Why Directors
& Officers of Privately-Held Corporations Are Worried About Losing Their
Personal Assets
The decisions of the “Cogan” case in May 2003 changed the landscape for legal liability arising out of the poor corporate governance of directors and officers of privately-held corporations, who have a good-faith, fiduciary responsibility to act in the best interests of the corporation, even if they own the corporation themselves. D&Os now find that they can be sued personally for their acts and that their own personal assets are at risk.
· “I am the sole owner and stockholder of a
privately-held, $100 million in sales, corporation.
I don’t see the need
for D & O insurance.”
· “In our
company, we have three owners who are also the directors and officers. We trust
one
another. There is no need for D & O
insurance.”
· “We have a closely-knit, family-owned private
corporation. We have never had a D &
O claim. We do not feel we need D & O insurance.”
· “They will sue the corporation but they won’t sue me
personally for my acts as an officer or
director.”
These are all sincere statements, made from the perspective of the
individuals who uttered
them.
In today’s legal climate and changing federal laws relating to corporate
governance,
these comments would be viewed as a denial
of the reality of business today or that those individuals
who uttered them simply do not appreciate the risks they face. When a D & O
suit
What is
Directors and Officers Insurance: Simply put, it is liability and defense cost
coverage for negligence arising out of the acts of directors and officers in the
performance of their duties— to act prudently, make informed decisions, perform
in Good Faith, and act in the best interest of the Company.
Capacity to Incur Uninsured Loss: If you make up part of the seafood industry
average, your Gross Profit is about 8% and your Net Profit Before
Taxes is about 1%, annually. At $50
million of sales, Gross Profit and Net Profit Before
Taxes are $4,000,000 and $500,000, respectively. What happens if you have an uninsured loss of
$1,000,000? It is obvious that you won’t
be making a profit for the next two years.
And working capital and retained earnings take a significant hit. In many cases, working capital is impaired
enough to cause a serious reduction in the ability to purchase income-producing
goods to continue making sales at the existing level.
Understanding the Risk:
· D & O suits are generally not covered by
your General Liability policy because there was no “property damage,” “bodily injury,” “personal injury,” or
“advertising injury.”
· Most privately-held corporations do not have
the same magnitude of resources as those of a publicly-held corporation.
· Many decisions made by directors and officers
of privately-held corporations are made without complete or accurate information.
· D & Os essential
duties.
Duty of Care – Prudent
man rule
Make informed decisions
Perform in Good Faith
Act in the best interest of the Company
· Common General Allegations
Wasting
corporate assets
Compromising
competitive industry position
Overlooking
significant growth or investment opportunities
Lowered
stock value
· Typical Specific Allegations
1) Failure
to procure insurance
2) Obtaining
defective insurance
3)
Entering into contracts with large, uninsured risks
4) Failure
to stop action resulting in damage to the company
5)
Unwarranted dividend payments, salaries or compensations
6) Failure
to attend meeting of Directors or Officers
7) Misuse
of company funds
8)
Imprudent loans resulting in loss to the company
9)
Inefficient administration resulting in losses
10)
Misstatement of financial reports
11)
Exceeding authority granted by Charter or Bylaws
12)
Violation of covenants in loan agreement or indenture
13)
Failure to disclose promptly information relative to significant developments
with respect to company
14)
Violation of any of the responsibilities, obligations or duties imposed upon
fiduciaries by the
retirement income security act of 1974 or amendments thereto.
15)
Antitrust Violations
16)Breach of duty to minority stockholders
17)
Failure to honor employment contract
18)
Illegal payment to public official
Frequency of Loss
According to the most recent Watson
Wyatt Company survey, 31% of all companies could expect to have at least one
claim against its directors and officers and each company averaged 0.87
claims. Both are all time highs. The 1997 Wyatt survey showed that 45% of
suits against directors and officers of privately-held companies are employment
related. The remainder of suites against
private company officers and directors come from shareholders, 21%, customers,
19%, competitors, 8%, other third parties, 6%, and government, 1%.
Marine cargo, workers compensation,
and automobile insurance aside, a seafood business would be hard pressed to
identify a line of insurance in its portfolio that would present a loss
frequency similar to directors and officers liability suits. When it comes to pure large loss liability,
there are none similar.
Loss Potential
The largest average payment to
claimants is $7.2 million to Shareholders, $5.7 million to Government or Other
third parties, $2.1 million to Competitors, $1.9 million to Employees, and $250
thousand to customers. Defense costs
(attorney’s fees) ran between 10% and 50%, depending on the nature of the law suit. It is not uncommon
D & O suits, right now, are
largely uninsured. The frequency is
often enough and the loss potential is great enough to seriously deplete the
life-long personal asset accumulation of a director or an officer.
Comparison to Other Covered Perils
Most privately-held corporations
spend a lot of premium dollars on life, health, disability, and other benefits
for an officer or director—far in excess of the per person cost of D &
O. At the same time, corporations
purchase insurance on the risks such as fire, wind, earthquake, flood, and
general liability, where the frequency of loss is very low and the loss
potential is high. Additionally, very
low deductibles are employed relating to these risks—exhibiting an apparent
risk aversion. On the other hand, D
& O risks, which happen more frequently and with greater severity, go
uninsured—putting the officers, directors, and the corporation at great
financial risk. Does this make
sense? Perhaps it could be said that an
informed, quality decision was not made in this instance.
Bioterrorism and Acting Prudently
The federal government has made bioterrorism
a corporate governance issue by placing the responsibility for bioterrorism
planning squarely on the shoulders of American business. Businesses must conduct their own assessments
to protect their key assets, shareholders, employees, and the nation. This suggests that corporate decision-makers
may face increased liability for terrorism and security, particularly if they
do not act prudently. Considering
security measures only after an event has occurred creates serious duty of care
liability issues for corporate decision-makers.
Specifically, the duty of care has two facets—decision-making and
oversight. D & Os have a duty to
protect corporate assets and minimize third-party liability exposure. In the case of the potential bioterrorism
threat, assessing vulnerabilities and implementing security measures may have
significant legal consequences. At the
same time, under the D & O’s oversight responsibilities, monitoring the
corporation’s business policies and procedures is paramount. A director or officer may face significant
personal liability for corporate inaction if he or she was fully informed and
attentive but failed to take appropriate action. How have you dealt with your potential
bioterrorism risk so far?
D&O
insurance is available and affordable. Contact
Capitol Risk Concepts,
Ltd. Tel: