You have been asked to act as a director for a company. Understanding your potential exposure as a director or officer is essential to protecting not only your entity but your personal liability. Acting as a director or officer creates personal exposure and can impact coverage under your errors & omissions policy. In addition, as a professional, you may be held to a higher standard of liability. This article is intended to assist you in evaluating your exposure, and direct you in asking the necessary questions for your personal protection.
Often, professionals such as CPAs, lawyers, and investment advisors are sought after to sit on local boards for their specialized expertise. In some cases this is a good opportunity for the local professional to increase his or her exposure in the community. Often, more established professionals seek ways to give back to the community. And frequently, the request comes from a client with whom you have an established professional relationship.
Whichever reason has you evaluating a decision to sit on a board as a director or officer, you need to consider conflicts of interest, risk assessment, and insurance protection.
We start by separating board positions by the following categories:
You, or your firm:
- provide professional services to the related entity
- provide no professional services to the related entity
The board position is for:
- a non-profit entity
- a private, for-profit entity
- a public-traded entity
The most common requests come from community non-profits (about 1.5 million exist in the US).
Conflicts of Interest.
If you, or your firm, provide professional services to the related entity, you should be aware that accepting the role as a director or officer may impact your Errors & Omissions Insurance (E&O). From an insurance perspective, serving on the board of a client to whom you also provide professional services may be considered a conflict of interest. An E&O policy typically does not extend coverage to your role as a director or officer. In addition, acceptance of such a role may limit or exclude the professional services your firm provides to your client.
Each E&O policy is unique, but almost all contain some level of “outside interest” exclusion. Understanding how your policy may respond is critical in the decision process prior to accepting a board position. Too often the analysis only happens after a claim is made, obviously the wrong time to determine policy coverage.
Error and omission policies generally have seven ways to interpret coverage when providing professionals services while sitting on a board of directors.
- Absolute exclusion – if you provide services to a client with whom any of your professionals serve as a director or officer, there is no coverage provided should a claim arise.
- Sub-limit of insurance protection – this policy limits the amount of coverage provided, and typically limits coverage to defense of a claim only, with no coverage for damages
- Silent on coverage – even if your policy does not specifically address coverage for outside interests, other conditions in your policy may impact coverage, such as, the definition of “professional services” and the definition of “insured”.
- May allow coverage for non-profits only – the outside interest exclusion does not apply to services provided to non-profit entities for which you act as a director or officer.
- May allow coverage for limited services - the outside interest exclusion does not apply to limited services, such as, tax returns performed by your accounting firm.
- May cover professional services if completed prior to being on the board – coverage is still available for services prior to your acceptance as a director or officer, but excluded once that role is engaged.
- May offer coverage by endorsement – in particular circumstances, and subject to underwriter approval, the carrier may add coverage back to the policy via endorsement.
Keep in mind that this coverage is relevant to the services that you provide to the entity. Only a few professional liability policies provide “outside director liability”, protecting you for your role as a director or officer. In all cases, such coverage is limited in dollar amount and to non-profit entities.
Each policy should be reviewed to the relevant coverage and then an informed decision made weighing the pros and cons. If you and your firm do not provide professional services, then your E&O coverage becomes less of a concern, and we can concentrate on your personal exposure.
As a director or officer you assume a personal liability. This means that your own assets – your house, your car, your bank accounts – are at risk. Even if a claim is not valid, defending a lawsuit can be both an emotional and financial drain.
As a director or officer you owe a duty to the relevant shareholders and employees of that entity. Public entities obviously hold the largest exposure in this situation. However, it is important to understand the significant exposures faced by private and nonprofit companies as well. Potential claims can arise from shareholders, employees, competitors, customers, third-parties, and be based on a number of potential exposures including:
- Securities Law
- Employment Laws
- Business / Corporate Law
For private companies and non-profit organizations, the greatest risk for directors and officers is employment-related lawsuits. 48% of lawsuits against private companies are employmentrelated, and this jumps to 98% for suits against the directors of nonprofit organizations (Directors and Officers Liability: 2005 Survey Executive Summary, Towers Perrin Tillinghast).
It is public policy for organizations to indemnify their directors and officers for the defense, settlement, and judgment resulting from lawsuits related to these roles. In fact, every state requires indemnification when directors and officers are successful in their defense against a lawsuit. Always request a written indemnification document.
However, there are always exceptions when indemnification cannot be granted, and indemnification can come after lengthy defense costs are incurred. For this reason, a directors & officers insurance policy should be the first line of defense. Our recommendation to our clients is to never accept a board position where the entity does not have a directors and officers liability policy in place.
Furthermore, not all policies are the same, and the policy should be reviewed in detail. You will want to be able to answer the following questions:
- What limits of liability are available and are they sufficient?
- Does the policy provide coverage for my position?
- Are there any coverage exclusions, conditions, or modifications that could impact coverage in the event of a claim?
- Have there been claims or potential claims reported that could impact limits available to me?
- Does the policy provide coverage to me as an individual, as well as, the whole board?
Does the policy provide additional coverage for:
- Employee-related events (employment practices liability)
- Fiduciary (ERISA and health & welfare plans)
- Employee dishonesty / theft
Always have your insurance policies reviewed by an insurance broker with experience in that particular field.
Serving as a board member can be very rewarding, and many professionals serve in this capacity on a regular basis. Understanding your potential exposure will assist you in your assessment of whether to take this new position and, ultimately, will provide you with peace of mind in your role.
Gary Sutherland of NAPLIA