Directors and Officers (D&O) Insurance: Coverage, Policy Types and Who Needs It

The Nebraska alert lists claims alleging misrepresentation or improper use of company funds among the claims D&O policies can address. It also warns that "you can be sued individually and separately from your company," and that a company's general liability policy may not cover you as an individual. Nebraska DOI D&O consumer alert.

The policy's definitions decide what triggers coverage. Travelers' published private-company specimen, form PDO-3001 (edition 01-09), defines a wrongful act as "any actual or alleged act, error, omission, misstatement, misleading statement or breach of duty or neglect" by an insured person acting in that role, or by the organization. In that form, a claim includes more than a lawsuit, such as:

• a written demand for money or other relief;
• a criminal proceeding or a formal administrative or regulatory proceeding;
• certain arbitrations and mediations;
• a written request to toll or waive a statute of limitations.

Covered loss in that form includes defense expenses, settlements and judgments. It excludes fines, sanctions, taxes and amounts uninsurable under applicable law. Travelers private-company D&O specimen PDO-3001, sections I and III.

Hypothetical example: A minority owner of a 30-person distribution company writes to the board demanding that it cancel a lease with a business owned by the CEO's relative. No lawsuit has been filed. Under wording like the Travelers specimen, a written demand can itself be a claim. The first questions are whether the letter must be reported now, who is named, and which insuring agreement could respond.

Any organization whose directors, officers, trustees or managers could be sued over how they run it may want to consider D&O coverage, whatever its size. Nebraska's insurance department notes that when someone makes a claim against a company, its directors and officers are "typically named in the lawsuit," and that organizations "regardless of size, often purchase D&O insurance to protect their employees." Nebraska DOI D&O consumer alert.

Three situations deserve a closer look:

• A document calls for it. Check your bylaws and any investor, lender or grant agreement for an insurance or indemnification requirement.
• The organization cannot always pay for its leaders. State law limits indemnification, as the Delaware example below shows, and Side A is the part written for that gap.
• People outside the business serve on your board. Their roles must fit the policy's definitions; Travelers' nonprofit specimen, for example, adds trustees and volunteers to its insured persons. Travelers NDO-3001, definition II.H.

The sections on private companies, nonprofits and public companies below cover what changes by organization type.

The Nebraska Department of Insurance describes three typical D&O coverages. Directors and officers are protected when the company can't compensate them. The company is reimbursed when it does compensate them. "Entity coverage" protects the company if both the organization and its officers are named in a lawsuit. Nebraska DOI D&O consumer alert.

In Travelers' specimen forms they appear as Insuring Agreements A, B and C. Travelers PDO-3001, section I.

Why Side A matters: limits on indemnification

Indemnification means the organization pays a leader's legal costs or liability. State law limits it. In suits brought by or in the right of a Delaware corporation, such as shareholder derivative suits, the statute limits indemnification to expenses, including attorneys' fees. It bars indemnification for any matter in which the person is adjudged liable to the corporation, unless a court approves. Delaware Code, Title 8, § 145(b).

When the organization cannot pay or is not permitted to, Side A is the part written for the individual. If a claim's loss exceeds the remaining limit, Travelers' private-company specimen pays Side A loss first. The organization can also ask in writing, through an executive officer, for Side B and C payments to be withheld. Travelers PDO-3001, condition VI.F.

Retentions and presumed indemnification

A retention is the amount the insured pays before the insurer does. Under Travelers' liability terms, no retention applies to an insured person when indemnification is not permitted by law or the organization cannot pay solely because of financial insolvency. The same terms treat the organization as having indemnified its leaders wherever law, contract, charter or bylaws permit or require it. Travelers liability terms LIA-3001, condition III.B.

Ask how your proposed policy treats a director when the organization is legally able to indemnify but does not. In Travelers' private-company specimen, Side B and its retention apply to legally permissible indemnification "whether or not actual indemnification is made," unless financial insolvency is the only reason it is not made. Travelers PDO-3001, condition VI.C.

Separate Side A policies

Some programs add a policy that protects only individuals. Travelers' Broad Form Plus+ specimen (BFP-16001, edition 11-13) pays loss for insured persons "that is not paid by any other insurance or as indemnification from any source." Travelers lists it under "Side A DIC Forms," with applications for private, nonprofit and public companies. Ask how such a policy would sit alongside the primary D&O policy. Travelers Side A specimen BFP-16001; Travelers D&O forms library.

Two definitions decide whether you are protected: the insured person and the insured organization. In Travelers' private-company specimen:

• Insured persons include past, present and future directors, officers, executive officers, board-of-managers members, employees and members of management or advisory committees.
• The insured organization is the named insured, any subsidiary in which it holds more than 50% of the securities or voting rights that control the board, and the company as a Chapter 11 debtor in possession. Travelers PDO-3001, definitions III.D and III.L.
• Outside positions are service as a director, officer or trustee of certain tax-exempt organizations, or of entities scheduled by endorsement, but only with the company's knowledge, consent and specific request.
• Estates and heirs: a claim against an insured person's estate, heirs or legal representatives after death, incapacity or bankruptcy counts as a claim against that person.

Travelers PDO-3001, definitions III.E, III.H and III.I.

Travelers' nonprofit specimen (NDO-3001, edition 01-09) adds trustees, volunteers and members of duly constituted committees to its insured persons. Travelers' shared liability terms (LIA-3001) also extend coverage to a spouse or domestic partner, but only for claims arising from the insured person's own wrongful act and subject to conditions. Travelers nonprofit D&O specimen NDO-3001, definition II.H; Travelers LIA-3001, condition III.M.

Ask for written confirmation that your title fits the definition: LLC manager, advisory board member, nonprofit trustee or a seat on an affiliate's board. If you are about to join a board, the D&O questions to ask before joining a board cover the documents to request.

The Travelers private, nonprofit and public company specimens each state on their first page that they are claims-made coverage with defense expenses included in the limit of liability. Defense spending therefore reduces the amount left for settlements or judgments. Travelers PDO-3001, page 1; NDO-3001, page 1; PCDO-16001, page 1.

The Texas Department of Insurance explains the vocabulary in its general-liability guide:

• Claims-made policies cover claims reported to the insurer during the policy period; events before that period need special arrangements.
• Prior-acts coverage is set by a retroactive date. That date usually appears on the declarations page and may be the policy's effective date or earlier.
• Known claims: prior-acts coverage does not cover claims that were known when the policy began.
• Tail coverage, or an extended reporting period, pays for claims made after the policy expires.

TDI claims-made and occurrence explanation.

D&O forms may control earlier matters with other dates. Travelers' private-company specimen uses three exclusions:

• claims arising from proceedings pending on or before a "Prior and Pending Proceeding Date";
• matters an executive officer knew about before a "Continuity Date";
• matters already reported under an earlier policy.

Ask which dates appear on your declarations, and whether a replacement policy carries forward the dates from your current one. Travelers PDO-3001, exclusions IV.A.4–6.

Reporting a claim or a potential claim

Travelers' liability terms make written notice of a claim "as soon as practicable" a condition of coverage. They also require the insurer's consent before you settle or incur defense costs. Notice of a potential claim given during the policy period makes a later claim count as made in that period. Related claims count as a single claim, made when the first one was made. Travelers LIA-3001, conditions III.F–H.

Extended reporting and a sale of the company

In the same terms, the named insured can buy an extended reporting period within 60 days after the policy is terminated or canceled for a reason other than nonpayment. It applies only to wrongful acts wholly before that date, with no new limit. A "change of control" includes an acquisition or a party gaining the right to elect more than half the board. After a change of control, coverage continues only for earlier wrongful acts. The option to buy a run-off reporting period ends unless it is elected, with payment, within 30 days. Travelers LIA-3001, definition II.D and conditions III.K and III.O.

The Nebraska Department of Insurance says D&O policies do not cover illegal activities like fraud, and also do not cover personal profiting, bodily injury or property damage. Nebraska DOI D&O consumer alert.

The wording also decides when an exclusion applies. Travelers' private-company specimen shows how much detail sits behind each label:

Travelers PDO-3001, exclusions IV.A–B (bodily injury and property: IV.A.1–2) and section V.

Travelers posts separate D&O applications and specimen forms for private companies, nonprofits and public companies, and the differences matter. Travelers D&O forms library.

Sources: PDO-3001; NDO-3001; Travelers public-company specimen PCDO-16001 (rev. 12-17).

Private companies

As the table shows, entity coverage in Travelers' private-company form is broader than in its public-company form, so ask what the entity-only exclusions take away. If you are planning a fundraise, read the securities-offering exclusion first. In the Travelers specimen, it does not apply to offerings exempt from registration. For other offerings, the company can request a proposal for coverage, with any added terms and premium, by giving the insurer notice at least 30 days beforehand. Travelers PDO-3001, exclusion IV.A.11.

Nonprofits

The federal Volunteer Protection Act limits the liability of an uncompensated volunteer for harm caused while acting for a nonprofit. The protection has conditions. For example, the volunteer must have acted within the scope of their responsibilities, and it does not reach harm caused by willful or criminal misconduct, gross negligence or reckless misconduct, or by operating a vehicle that requires a license or insurance. 42 U.S.C. § 14503.

The Act's definition of volunteer includes directors, officers and trustees who do not receive compensation, other than reasonable expense reimbursement, or anything of value in lieu of compensation, in excess of $500 a year. The Act leaves the organization's own liability, and its claims against its own volunteers, unaffected. 42 U.S.C. § 14503; 42 U.S.C. § 14505.

Boards of organizations exempt under section 501(c)(3), (c)(4) or (c)(29), other than private foundations, also face an excise-tax exposure. Under section 4958 of the Internal Revenue Code, an organization manager who knowingly participates in an excess benefit transaction owes a tax equal to 10% of the excess benefit, up to $20,000 per transaction, unless the participation was not willful and was due to reasonable cause. 26 U.S.C. § 4958.

Travelers' nonprofit specimen counts that manager tax as covered loss up to $20,000. Its covered loss excludes the 25% tax assessed against a "disqualified person" and the 200% tax for failure to correct the transaction. Travelers NDO-3001, definitions II.D and II.I.

Treasury regulations count an exempt organization's payment of liability insurance premiums for section 4958 taxes as compensation when testing reasonableness, unless the payment is a de minimis fringe benefit. Ask counsel how your organization treats that premium. 26 CFR 53.4958-4(b)(1)(ii)(B).

Public companies

The SEC requires a public company to describe the general effect of any statute, charter provision, bylaw, contract or other arrangement that insures or indemnifies its directors and officers. 17 CFR 229.702.

Certain registration statements must also state that, in the SEC's opinion, indemnifying directors, officers and controlling persons for Securities Act liabilities "is against public policy as expressed in the Act and is, therefore, unenforceable." Where indemnification is unavailable, Side A coverage is the protection written for the individual. 17 CFR 229.512(h).

An insurer prices D&O from your organization's application and the terms you request, so the useful comparison is between proposals for your organization. Travelers' small private-company D&O application (PDO-1100W-IND-SMB, edition 01-09) shows what one insurer asks:

• Employee count, subsidiaries, securities filings and private placements.
• Mergers, acquisitions, divestitures, closings or layoffs, debt-covenant violations and reorganizations in the past 24 months, or expected in the next 12.
• Ownership, including each shareholder holding more than 5% of any class of security.
• Board or senior-management changes in the past three years, and loans to directors or officers.
• Financial statements, including assets, liabilities, revenue, cash flow and net income, and any going-concern opinion.
• The requested limit, the current limit, retention and premium.
• Known facts that could lead to a claim, and claims or proceedings in the past three years.

Travelers small private-company D&O application, sections I–V.

That form accepts only privately held commercial companies with 250 or fewer employees and $100 million or less in both assets and revenue. Ask each insurer for its own application. Travelers small private-company D&O application.

The terms you request belong in the same comparison. In Travelers' liability terms, the declarations can add a separate defense limit. They also specify either duty-to-defend coverage, where the insurer defends and selects counsel, or reimbursement coverage, where the insured defends and the insurer advances defense costs on written request. Travelers LIA-3001, conditions III.D–E.

Gather the declarations, the coverage form, the general terms and every endorsement for each proposal. Record a page reference for each answer, and leave any unanswered item marked as unknown.

Our guide to reading business insurance policies explains how these documents fit together. The quote-comparison worksheet keeps two or three proposals and their open questions side by side.

Request coverage help if you would like PolicyBenchmark to follow up on your D&O questions. The request is an inquiry to PolicyBenchmark; a licensed insurance professional and the issued policy determine any coverage.

• Bodily injury and property damage: the Nebraska and Travelers sources above place these outside D&O. See the general liability coverage guide for that separate category.
• Client services: if a client alleges a mistake in work you deliver, compare the D&O wording with your professional liability (E&O) policy rather than assuming either responds.
• Employment claims: check whether the D&O entity coverage excludes employment claims, as the Travelers specimens do, and where the organization's own employment claims are insured.
• Benefit plans: the Travelers private-company specimen excludes ERISA and benefit-plan claims, so ask how fiduciary liability is handled.
• Umbrella and excess: ask whether any umbrella policy lists your D&O policy as underlying insurance, or whether higher D&O limits would come from separate excess D&O. Travelers posts its own excess-policy application in its D&O forms library. Our commercial umbrella insurance guide explains how umbrella layers sit over other policies. Travelers D&O forms library.