Served in late June, the lawsuit alleged that the executive director was guilty of sexual harassment and discrimination. Damages in excess of $500,000 were sought. Shaken, the board turned the lawsuit over to its insurance broker to obtain a defense under its general liability policy. At the next meeting of the board, the broker read a letter from the insurance company informing the organization that there was no coverage for employment-related claims under the general liability policy and that they should look for coverage under their Directors and Officers liability policy. The directors looked at each other with pained expression. They had previously decided not to purchase Directors and Officers liability insurance containing the broad coverages they needed to personally protect themselves.¹

There are numerous causes of action to which directors and officers are exposed during their tenure, including lawsuits imposing strict liability, slander, breach of fiduciary duty, Sarbanes-Oxely, economic torts, common law torts, simple negligence through omissions and other employment-related claims. This article discusses the need for Directors and Officers liability insurance ("D&O insurance") for actions of directors and officers not covered by other insurance policies.

While standard general liability insurance policies protect directors and officers with respect to the liabilities emanating from business operations, these policies do not protect the directors and officers for wrongful acts committed as fiduciaries. To protect the personal financial assets of their boards and senior management, as well as the assets of the corporation, D&O insurance needs to be considered for these individuals.

In addition to the traditional causes of actions stated above, restrictions on competition by a former employee have become an increased cause of litigation involving directors and officers. These are traceable to one of four areas: noncompetition promises, trade secrets, transfers of ownership, and duties of loyalty (including breach of fiduciary duty). An exposure for a tort known as interference with perspective economic or business advantage (this tort also has a limited number of other variations), is an area of litigation and potential exposure that we have seen more of in recent years, and is grounded in violations, or alleged violations of non-compete agreements and breach of confidentiality agreements.

Restrictions on Competition
As the use of the above types of employment agreements increase, so do the exposures for litigation. This is true because companies often attempt to enforce non-compete or confidentiality agreements that are ultimately deemed unenforceable. That can result in an ex-employee suing his or her former employers, and directors and officers, in both their official capacity and as individuals, under any number of legal theories.

Employers who fire employees risk losing the right to enforce a non-compete provision, if the act of firing constitutes a breach of the employment agreement. Such a breach would expose the employer and the persons engaged in the breach to risk of being sued both in their professional and personal capacity.

The standard Commercial General Liability policy often will not cover a lawsuit by a former employer or a suit by an employee for claims against the employer for the wrongful filing of any of the above referenced claims. Therefore, it is essential for an employer to have D&O insurance to cover directors and officers in the event that either a counter-suit is brought under any of the legal theories stated herein, or in the event a prevailing ex-employee later sues the individual for malicious prosecution or some other cause of action.

Additionally, as a new employer, directors and officers can be exposed to claims of liability from a former employer when the departing employee, now a current employee of the new employer, brings along confidential information that violates a previous non-compete. Even simple negligence of the new employer in using the wrongfully obtained information exposes the new employer, and the directors and officers of that company, to a lawsuit by the former employer under a host of legal theories. D&O insurance would be a wise purchase on behalf of the directors and officers not covered in their individual capacity under the corporate general liability policy.

Public or Private: It doesn't matter
Directors and officers face liability exposure regardless of the size of their company, the nature of the business, or whether it is privately owned or a publicly traded company. Eighty-nine percent of all nonprofit groups provide liability insurance for their trustees, according to BoardSource, a Washington organization that assists nonprofit boards.

While publicly traded companies typically provide D&O insurance, such coverage may be even more important for privately owned companies that do not possess the financial ability to reimburse directors and officers for personal liability and financial judgments awarded against such individuals while acting in their professional capacity. Privately owned companies' D&O insurance may also incorporate coverage for employment practices liability and broader entity liability exposures.

Most organizations, both public and private, can benefit from D&O insurance.

When the Need for D&O Insurance Arises
Suing a former employee is not without risk. While such a lawsuit usually achieves its goal-to prevent competition-a lawsuit may ultimately be deemed to lack merit. As a consequence of this foreseeable economic injury and damage to reputation, a former employer who pursues a lawsuit found to lack merit is exposed to a broad variety of counterclaims: malicious prosecution, abuse of process, interference with perspective business relationships, and violation of the antitrust laws. The organization needs to provide D&O insurance to all of its directors and officers, likely to be named personally in such a lawsuit, in order to avoid loss of personal assets for actions taken in their official capacity and to attract qualified candidates for these positions.

New employers are also subject to lawsuits by former employers for claims including, but not limited to: inducement of the former employee to breach his employment contract with the former employer, misappropriation of trade secrets, and unfair competition. Again, the new employer should obtain the appropriate D&O insurance coverage to protect personal exposure.

Conclusion
In sum, effective directors and officers are essential to the success of any business, regardless of the size and nature of the business. Purchasing D&O insurance for your directors and officers is relatively inexpensive, can transfer the risk of exposure, and helps to attract and retain qualified people to assist in running the organization.


¹Directors & Officers, Key Facts About Insurance and Legal Liability, Nonprofits Insurance Alliance of California and Alliance of Nonprofits for Insurance