Directors and Officers (D&O) Liability Insurance Policies have historically had great importance to public corporations. Providing a defense or immunity for corporate officers and directors against derivative suits, securities and fraud violations, bankruptcy cases, creditor cases and bank failures, D&O policies generally go hand-in-hand with the title of "executive" within a public company.
It is not as prevalent however, for similar insurance policies to be in place for private companies. And without a policy protecting senior executives and shareholders from incurring personal liability as a result of work performed for the private corporation, owners and managers are discovering they can be held personally liable and responsible.
A case recently decided in Michigan, and currently being appealed to the state's highest court, illustrates the potential consequences for owners and directors of private companies who do not cover their personal liability through a D&O or similar policy.
The court upheld the ruling of an administrative law judge for the Michigan Labor Department which imposed personal liability on the directors and officers of a dissolved corporation for unpaid salaries. The judge ruled that the former CEO and owner of all voting stock of a company which had dissolved was an employer, as defined by the Payment of Wages and Fringe Benefits Act. Therefore, he was personally liable for back pay owed to employees. This decision was supported by the fact that the director was aware of the risk of financial failure yet continued to employ workers.
The language in the Act which was used in this case is also widely used in the United States Fair Labor Standards Act. In a wide range of circumstances, it can leave directors and officers vulnerable to personal liability for problems within a company. Prior court rulings, in addition to vague definitions and guidelines, can cause confusion for owners of private business with respect to this potential exposure.
Case in point. The Fair Labor Standards Act, which applies to all business engaged in interstate commerce. This Act was designed and enacted to maintain the minimum standard of living necessary for the health and general well-being of workers. Because "interstate commerce" is so broadly defined, the standards set forth in the Act apply to most businesses, both public and private, operating in the United States.
Pursuant to the Act, the definition of "employer" includes any person acting directly or indirectly in the interest of an employer in relation to an employee. This has been construed to include corporate directors and officers, and courts have increasingly been willing to adopt this broad definition and hold directors and officers personally liable for wages, benefits and overtime violations, and discrimination claims. This is especially true in circumstances where the directors and officers actively participate in the management of the corporation's business.
Statutes enacted in a majority of jurisdictions, including New York, Massachusetts and Louisiana, state that the directors and officers of corporations, both public and private, shall be held personally liable for corporate debts where they are guilty of certain delinquencies. Examples include failure to enact Workers Compensation coverage, failure to file articles of incorporation, or excessive indebtedness.
As a general rule, in order to be held statutorily liable, the director or officer must have expressed or implied acceptance of his or her office, and must be active in the management of the corporation at the time the debt was incurred.
For example, in Massachusetts, private corporate officers were held liable for participating in unfair and deceptive practices. These individuals were not immunized as officers and directors for acts which they allegedly committed personally. Officers and directors of closely held, privately owned corporations have also been held liable under CERCLA, pursuant to federal, New York and Connecticut law.
The broadening interpretations of the United States Fair Labor Standards Act and the Michigan Wages and Fringe Benefits Act illustrate two circumstances wherein the liability of corporate directors and officers is being expanded. Another was highlighted by the recent discrimation case against Texaco. This involves a once-obscure but increasingly popular form of coverage known as employment practices liability insurance, which helps cover the cost of such litigation.*
As more states enact employee-protective legislation, public and private businesses must recognize the potential ramifications, and implement measures to protect their corporate directors and officers from personal attack.
It is therefore important for potential victims to investigate and obtain adequate liability coverage. Through a comprehensive legal audit, Kaufman and Payton attorneys can uncover possible exposure and recommend insurance.
For example, many are surprised to learn that directors of not-for-profit organizations can also be potential victims, and that D&O entity coverage is available for these individuals and groups.
There is an evolving jurisprudence concerning the scope of coverage provided by D&O liability insurance policies. The most commonly litigated issues include the effect of material misrepresentations or omissions by a director or officer; and the apportionment of indemnity and defense costs between insured directors and officers and uninsured persons, and between covered and non-covered claims.
D&O liability insurance is not mandated by statute. Therefore, directors and officers are not prohibited from contracting for insurance with exclusions or additions as needed, so long as the exclusions are not specifically or generally prohibited by state statute.
The most common coverage exclusions for losses include: (1) arising out of proceedings brought by regulatory agencies; (2) arising out of violations of the securities laws; (3) arising from active and deliberate dishonesty on the part of officers or directors; and (4) based upon claims made against a director or officer by an insured director, officer or organization.
Furthermore, courts have widely recognized that D&O coverage may not extend to the corporation itself, or to other uninsured persons who contribute to the liability.
As with most other types of insurance, the terms, conditions and exclusions of D&O policies will vary depending on the insurer and the needs of the insured. However, the general language of a D&O policy names as insured "any partner, officer, director, stockholder or employee while acting within the scope of their duties as such," and covers the directors and officers when they are named as defendants in their capacities as corporate officials. Specifically, a D&O policy is often the vehicle to provide directors and officers with protection for EPLI, i.e. wrongful terminations, discrimination, sexual harassment and retaliatory treatment.
The trend in the current legal climate is toward expanding personal liabilities of directors and officers in both public and private corporations. As a result, it is increasingly important that directors and officers be protected in the event a claim is filed against them. D&O liability policies are a vital element to every corporate foundation.