Considerations for Private Company D&O (Big Picture Overview)

Every private company doesn’t necessarily need to purchase D&O insurance.  There are some scenarios, however, where it should be a priority (see 8 reasons private companies should have D&O insurance, here). If you are a private company that’s decided that you need D&O insurance, what’s next?

In this post, we’ll cover some of the critical elements when it comes to placing private company D&O insurance:

1. Choosing a qualified broker
2. Understanding duty to defend and duty to indemnify
3. Knowing your insurance limit options

1. Choose a Qualified Broker  

For many private companies, it’s not obvious that having a specialist place the D&O insurance is of critical importance. The question when looking for a broker for private company D&O insurance should not be, “Do you do it?” Instead, ask, “How much do you do?”

You want to work with an insurance broker who specializes in D&O insurance and works at a brokerage that places a lot of it. This is not to say that bigger is always better. However, a private company would want to avoid working with a brokerage that really doesn’t place much D&O insurance.

Why? First, these types of policies are highly negotiated contracts. You need someone on your team that is in the insurance market every day, and knows what are the latest available terms and conditions.

Second, you want to work with a brokerage that places a significant amount of these policies to ensure that private company insurance carriers will pay attention to your account.

Here’s the issue: there aren’t enough premium dollars in most private company insurance policies to incentivize insurance carriers to negotiate the policy very hard on any individual private company risks. This means brokerages that place a lot of D&O insurance get a lot more attention for their clients—and better insurance policies—from carriers compared to brokerages that broker fewer policies.

And, you may be surprised to hear that when negotiated by a skilled broker, a better-negotiated, broader policy is generally not more expensive than a poorly negotiated policy.

Of course, you don’t just want a solid D&O insurance policy; you also want any claims that arise under the policy to be paid. The chances that this will happen increase significantly when you work with a broker who has deep D&O claims management experience.

2. Understand Duty to Defend and Duty to Indemnify

When obtaining D&O insurance, remember that defense costs fall within a D&O insurance policy, and as such, erode the total limit available to pay a claim.

When obtaining coverage, you will want to understand if your policy is a duty to defend or duty to indemnify (sometimes referred to as non-duty to defend) policy.

The duty to indemnify option means that the insured selects its own counsel, and the carrier will reimburse for defense expenses. However, the carrier will only pay reasonable defense fees under the policy. This matters because in the world of private company insurance, there can be a gap between what the carrier regards as reasonable and what the insured regards as reasonable when it comes to D&O litigation.

A classic example is when the defendant wants to hire an attorney who charges $900 per hour. The carrier may say “reasonable” is no more than $600 per hour. In this instance, even if the defendant wants to pick up the $300 difference, the carrier may not approve the use of that counsel.

A duty to defend policy has some advantages and trade-offs as well. One advantage is that if there’s even one covered allegation in a piece of litigation, the carrier is required to pay the defense fees relating to all the allegations brought in that piece of litigation.

However, the trade-off in this scenario is that the carrier chooses defense counsel. And the carrier’s choice of counsel may not be what the defendant wants. It will still be a competent choice, but it’s important to understand that you, the private company, will not be in control of the decision.

3. Know Your Limit Options

Most younger private companies will only buy $1 million to $3 million in D&O insurance – and in fact, that may be all that’s available to that company. Carriers won’t necessarily put out big limits just because a company is willing to pay the premium.

As companies mature – especially as they are on the path to becoming a public company – private companies may start to look at $5 million or $10 million in D&O insurance.

As a general matter, it’s only the very high profile companies or those subject to high levels of regulatory oversight that can or should obtain limits that look more like public company limits.

There are several ways companies can determine an appropriate D&O insurance limit. Benchmarking is a commonly used method. Perhaps a better approach is to work through the common private company litigation scenarios, and then consult with outside counsel to understand the expected costs associated with them.

Here are a few of those scenarios:

• Government suits: It’s unusual for a government agency to sue private company directors and officers, but it does happen. Consider, for example, a government investigation and prosecution of directors and officers for securities fraud in the context of a private placement offering to raise capital. The government will not allow Ds and Os to use insurance proceeds to settle a dispute, so the company purchasing insurance should not include the potential cost of the settlement itself when calculating appropriate D&O insurance limits.
• Private suits: Private plaintiffs could sue directors and officers of a company for breaching their fiduciary duties, including in the context of the sale of a company for a price that the plaintiffs believe is inadequate. These settlements are typically small when compared to public company counterparts, but not insignificant for Ds and Os who could be personally responsible for the liability in the absence of insurance.
• Bankruptcy: If Ds and Os are sued in bankruptcy, for example by the trustee for breaching their fiduciary duties, the only alternative to their own pocket books is usually the D&O insurance.
• Employee Suits: The majority of private company lawsuits are employee-related matters. D&O insurance policies can be expanded to respond to these claims; but, if a company elects to expand coverage in this way, it should consider raising the total amount of insurance limits to accommodate the employment practice claims that may be brought against the policy. In the alternative, these employee claims can be addressed through a separate Employment Practices Liability insurance policy with its own separate insurance limit.

What’s Required of the Private Company to Get Started

As a private company seeking D&O insurance, once you know what you’re after, the carriers will need a few things from you before they will consider insuring your risk.

You will need to complete an application. You’ll also have to provide financial statements (which do not always have to be audited) and a capitalization table that lists your investors and their respective percentage ownerships.

Finally, you, the private company, will need to make representations that your directors and officers are not aware of any current circumstances that are likely to give rise to a claim under the D&O policy.

To expand further on the topic of private company D&O insurance, I’ll talk about some of the terms and conditions of a policy that you should be aware of in a future blog post.

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.