Individual Director’s Liability: Protecting Personal Assets from Professional Liabilities
There are many reasons to accept a position on a board of directors or as an officer of a company. The cause may appeal to you or you may see this as a way to give back to the community. You may derive additional compensation from this type of position, or it could be an honorary position. Whatever the reason, it’s important to remember that with these additional responsibilities comes additional risk. By accepting a position as a director or officer, you can be held personally liable for the decisions made and actions taken in that professional capacity. Every position for every entity carries personal exposure. But there are things you can do to limit personal risk.
The Risks Behind Directors and Officers Liability
To operate effectively, directors and officers must rely on a presumption of indemnification in their roles. This means the entities for which they serve will pay the costs of defense as well as any settlements and judgments against an individual director or officer for any litigation arising out of that individual’s service. Indemnification provisions can often be found in the organization’s by-laws, articles of incorporation, or separate indemnification agreements. If not, indemnification can also be established by legislation or legal precedent, depending on the state.
In the event of litigation against a director or officer who has indemnification from the entity, the entity’s directors and officers liability (D&O) insurance policy, if and when it exists, immediately kicks in.
D&O insurance provides coverage for defense costs and judgments or settlements from litigation against a director or officer for serving in that role. Once the policy limits of the D&O coverage are exhausted, the entity would be responsible for the remainder of the cost to indemnify an individual director or officer from its assets. If those assets are exhausted, at that point, even with an indemnification provision, the individual director’s personal assets are exposed.
Financial insolvency of the entity isn’t the only way a director’s or officer’s personal assets are exposed.
For example, some actions are simply non-indemnifiable or uninsurable. Those actions include fraud or criminal acts, gross negligence or intentional breach of duties as a director or officer, and conflicts of interest. In addition, a shareholder derivative action, which is litigation brought by the entity on behalf of the shareholders against the director(s), is not indemnifiable or insurable. Finally, there is the possibility of a dispute over indemnification between the entity and the individual. While the dispute is awaiting resolution, the costs of defense continue, and the individual could be held responsible.
Protection from Personal Liability
The best way to protect yourself is to take action prior to accepting any role that could lead to personal liability. When considering a position, investigate the entity’s corporate governance policies and procedures. Have an attorney review the corporate by-laws regarding indemnification, and have an insurance consultant review the entity’s D&O policy. If either the by-laws or insurance are unsatisfactory or nonexistent, you should accept the position contingent upon satisfactory changes or implementation of the indemnification provision, the D&O policy, or both.
Even with appropriate due diligence, there exists the potential for personal liability, and there is a corresponding insurance product to cover that liability. Individual or personal directors liability (PDL) insurance is a policy type that protects only the individual who purchases it, as opposed to corporate
D&O, which covers all board members, officers, and employees, as well as the entity itself.
A PDL policy can be a good option for many situations. PDLs are common among highly affluent individuals with significant assets to protect. Also, if you serve in a large number of director or officer positions, your exposure might be too broad to simply rely on each entity’s protection. PDL policies are also often purchased by those serving on non-profit boards because there could be concern regarding the non-profit’s financial ability to indemnify, and it may be too onerous to insist that the entity buy corporate D&O insurance, given its budgetary limitations. Finally, PDL policies are often considered when there are concerns about the corporate governance of the entity or the entity’s ability and/or willingness to indemnify.
PDL policies provide very broad coverage with minimal exclusions when compared to a corporate D&O policy. PDL policies apply as excess, meaning in addition to, any indemnification you may receive from the entity or from the entity’s D&O policy. In the event there is no indemnification, these policies apply immediately, with no retention. This means that coverage would be available for the very first dollar of defense or liability with the insured bearing no financial responsibility.
New Insurance Protections
Recently, insurers have been working to develop a new version of PDL insurance that provides blanket coverage for families, rather than individuals. In the family office community, this structure could provide a lot of functionality for high profile, active families. Under this new structure, coverage is provided on a blanket basis for all family members for all positions in which they serve as a director or officer, regardless of whether the entity is public, private, or non-profit. This kind of policy allows larger or multi-generational families with members serving in many capacities to protect the family’s wealth as a whole, aggregating the exposures into one policy to create purchasing leverage. Similar to a PDL policy, this would apply after any indemnification received, or immediately if the individual is indemnified.
Accepting a role as a director or officer of a company, regardless of entity or motivation, brings more responsibility than just the duties or functions of the position. Due to the potential exposure of personal assets, caution is recommended prior to beginning any new role. If your or your family’s exposure is high enough, or if there are significant personal assets to protect, an appropriate insurance policy should be considered to safeguard those personal assets from liabilities arising out of serving in this professional capacity.