How D&O Insurance Can Deter Frivolous Lawsuits

A company’s directors and officers may be sued due to faulty decisions taken as a part of their duties. Adverse news events are all too common in today’s complex legal scenario. Organizations constantly face the threat of liabilities and litigation.

This type of litigation is often convoluted, and companies struggle to understand how insurance can help. Essentially, they want to know how a relevant insurance policy will respond to different (typical) litigation scenarios involving directors and officers.

This article will offer some clarity to the situation. It will discuss the common types of lawsuits and how directors’ and officers’ insurance would respond to each to deter it. 

Government Lawsuits

When it comes to government lawsuits, D&O insurance covers defense costs for the individuals involved. It’s important to keep in mind that penalties and fines are usually not covered under this insurance as they’re not insurable.

Many directors’ and officers’ insurance providers cover defense costs even if the government inquiry in question is informal. However, the investigation of the corporate entity (be it formal or informal) is not covered under this type of insurance.

Private Litigation

On the side of private lawsuits, there can be the following four scenarios. Let’s look at how directors’ and officers’ insurance would respond to each.

Registration Statement or IPO Lawsuits

This lawsuit is filed against a company’s directors and officers when its stock falls below the issue price due to some disclosure. The litigation will allege certain omissions or misstatements in the company’s registration statement.

Since registration statements have a statute of limitations of three years, the company’s directors and officers can be sued for up to three years from the time the business became public. In such a scenario, the Side B coverage of the directors’ and officers’ insurance would reimburse for indemnification obligations.

This response will come after the company has paid its self-insured retention or SIR. In any case, the SIR must be paid only once for every litigation involving the same underlying facts. 

Classic Stock-Drop Litigation

A company’s directors and officers may be sued for other types of stock drop. The primary difference may be that plaintiffs sue the directors and officers due to intentional misrepresentation of statements or omissions in the quarterly or annual filings. 

As a result, they become vulnerable to a securities fraud lawsuit. This is precisely why Oakwood D&O Insurance Brokers consider directors’ and officers’ insurance to be the most complicated insurance line in the market. 

To deter a classic stock-drop litigation, the policy will offer similar coverage to the previous registration statement lawsuit. 

Bankruptcy Lawsuits

Another kind of major litigation filed against a company’s directors and officers is a bankruptcy lawsuit. This is indemnifiable by the company and is usually filed by its creditors. 

It’s important to mention here that not all bankruptcies lead to a lawsuit, but most do. Now, the question is, does directors’ and officers’ insurance protect against such a lawsuit?

Yes, the directors and officers receive protection via Side A coverage. This coverage protects the individuals when they’re not indemnified by law or for public reasons as a result of insolvency. 

Derivative Lawsuits 

In most cases of stock-drop suits, the same are accompanied by a derivative lawsuit. Under the derivative lawsuit, shareholders file a suit against the directors and officers on the company’s behalf. 

They may allege that the company’s directors and officers have breached their fiduciary duties, thus harming the corporation. This lawsuit is typically only filed when the directors and officers have failed to take corrective actions. 

These lawsuits form a part of the state corporate law. In case it is filed, the directors’ and officers’ insurance policy will respond in the following ways –

  • The directors and officers can be indemnified for defense costs. Then, Side B coverage of the policy will reimburse for these costs once the SIR is paid. 
  • If the defense costs are indemnifiable, Side A coverage will respond on a first-dollar basis. However, there will be no self-insured retention involved here. 
  • If a company defense element is present in the claim, Side C coverage will respond to the costs with certain sub-limits for corporate investigations. 

In the final analysis, Side A, B, and C coverage of directors’ and officers’ insurance together ward off lawsuits that may damage a company’s market credibility. If you’re wondering whether your business needs this coverage, it depends upon its size and nature of operations. 

However, it must be seriously considered since the current economic scenario is gloomy, laden with concerns regarding recession and ESG. This increases the risk of frequent D&O losses for companies. 

As a new year has begun, businesses must realize that besides shareholders, D&O threats come from vendors, customers, and other third parties. Even small, family-owned businesses are not immune from such threats. 

Given the gravity of the situation, chances of keeping balance sheets intact are higher with a solid D&O policy in place. 

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