If you do a Google search for D&O insurance, you’ll find plenty of articles from prospective insurance providers and agents urging you to get D&O insurance for your privately held company.  In some cases, the company has a legal obligation to indemnify directors and officers for certain kinds of losses, and an insurance policy is a sensible way of financing that obligation.  In other cases, a prospective or existing director or officer will insist on D&O insurance before they will serve.  But of all the things you should consider spending your money on, you may decide you don’t need insurance right away.

Does my company have to indemnify directors and officers?

If you are a corporation, yes. If you have some other structure, possibly.

Corporations are obligated to indemnify directors and officers for certain types of losses, are permitted by law to indemnify them above the minimum statutory levels, and in many cases can advance expenses to them before a claim is finally resolved.  The statutory indemnification provisions also dictate where the company is not allowed to indemnify directors and officers.

Laws on other entity forms may not require indemnity, but frequently allow it.

At the end of the day, it’s more likely than not that your formation documents are drafted to provide the greatest amount of indemnity protection available under law, including provisions that require the company to pay the expenses incurred by a director or officer as they come up, even before a claim is finally resolved.

Does my general liability insurance cover these issues?

No.  Your general liability insurance policy doesn’t cover the type of director and officer liability that is covered under a D&O policy.

What losses are covered by D&O policies?

D&O policy coverage is commonly broken down into three “sides”:

  • Side A covers direct losses of directors and officers.  Direct losses are those losses of a director or officer that the company doesn’t indemnify them for, such as losses that the company cannot legally indemnify for or that it can’t pay because it is insolvent. The directors and officers are the insured persons under Side A.
  • Side B reimburses the company for losses on claims made against directors and officers that the company has covered.
  • Side C coverage is for losses incurred from claims against the company itself, usually limited to securities claims.

There is also something called Side D coverage that may be available for derivative suits, and is probably the least of a start-up’s concerns.

D&O policies are claims-made policies with a stated liability limit that is shared among the insured persons (so any coverage paid to one insured for defense costs, for example, lowers the amount of coverage that the other covered persons have).

While many policies include coverage for more than one of these sides, there are policy variations available that may make sense in your situation.  For instance, “Side A”-only policies may be cheaper and really all the board cares about, and there are policies that cover outside directors only (and similar variations that cover officer liability only).

This discussion is extremely truncated.  There are many specific clauses of the policy itself to carefully consider when you sit down to review a prospective policy, such as arbitration with the insurer, severability, pay-as-you-go defense costs, fraudulent conduct and personal profit exclusions.

Is it expensive?

Not necessarily.  It may be as little as $500 per year per million of coverage.  Like lots of other types of insurance, you can reduce the premium cost by increasing the deductible the company has to pay before the insurance kicks in (“retention” in the language of policies).  But this obviously has its tradeoffs – if the company has to pay out before the insurance coverage begins, what impact will that have on your cash flow?

Do I need D&O Insurance?

In general, at the beginning, you may not.  If your board is small (or just you), you have only founder stockholders, you aren’t doing any fund raising yet, aren’t for sale and don’t have any non-founder employees, it may not make sense to spend money on D&O coverage.

You should definitely think about D&O insurance if you take outside investments, if you get an outside director, if you have non-founder stockholders or employees who own shares (especially if you are selling the company).  Lead investors and outside directors will likely condition their investment or board service on being adequately covered.

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