Directors and officers (D&O) insurance provides coverage in the event that legal action is taken against a company director or officer. Here’s how it works.
What is directors and officers (D&O) insurance?
Directors and officers (D&O) insurance is designed to protect the assets of corporate directors and officers if they’re sued by employees, customers, vendors, competitors, shareholders or other relevant parties.
Actual or alleged reasons for legal action could include:
- breach of duties resulting in financial losses or bankruptcy
- misrepresentation of company assets
- misuse of company funds
- inadequate corporate governance
- failure to comply with workplace laws
- theft of intellectual property.
D&O policies cover a variety of events, but they generally exclude fraud, criminal activity and illegal profits. This means if a director or officer is genuinely involved in fraudulent or criminal activity, a D&O policy will not pay out a claim.
WHO IS COVERED BY D&O INSURANCE?
D&O policies typically specify the individuals and entities covered as ‘insured persons’. Insured persons can include:
- executive directors
- non-executive directors
- the company secretary
- executive officers
- employees involved in managing the company.
Exactly who is covered will depend on the insurer and the policy, so it’s a good idea to read the product disclosure statement (PDS) before committing.
What does D&O insurance cover?
Generally, D&O insurance covers personal losses and can help reimburse a company for the legal fees or other costs incurred in defending directors and officers against lawsuits. This can include:
- legal representation fees, damages, judgements and settlements
- business crisis costs and public relations expenses
- deprivation of asset costs
- costs resulting from extradition proceedings
- losses incurred for civil fines and penalties.
D&O insurance case study
Let’s look at a hypothetical case study to highlight how D&O insurance works.
A small business has a net asset position of $1 million and a line of credit for $200,000. Due to an economic downturn, the business’ clients continuously delay making payments – leading to negative cash flow and causing the director to fully utilise the business’ line of credit.
Over a period of six months, the business goes into liquidation. The liquidators make a claim against the business, alleging that the director continued operating while the business was insolvent.
The business’ D&O insurance policy covers the cost of paying the owed amount to the liquidators, as the legal fees.
Is directors and officers insurance necessary?
In an ideal world, your business would never have to face legal action – but the reality is all public, private and non-profit companies face some level of legal risk. Legal action against a company director or officer can be an expensive affair that could quickly sink a business without adequate cover in place.
And contrary to common belief, D&O insurance doesn’t just apply to large corporations or publicly-listed companies. In fact, SMEs with fewer assets could stand to benefit just as much, if not more, from protection against costly legal proceedings.
Choosing whether or not to take out D&O insurance depends on the level of risk you are willing to accept as a business owner. Conducting a risk management assessment will help you determine whether D&O insurance is a necessary investment for your business.
Disclaimer: The guidance provided is general in nature. The guidance is factual information only and is not intended to be financial product advice, legal advice or tax advice and should not be relied upon as such. The guidance has been prepared without taking into account your personal objectives, financial situation or specific needs. Before acting on any guidance you should consider the appropriateness of the guidance having regard to your objectives, financial situation and needs. Before making any decisions, it is important for you to consider these matters and to seek appropriate financial, legal, tax, accounting and other professional advice.
