A small business owner may need to purchase specialized liability insurance to cover gaps in a comprehensive general liability policy.
Corporations frequently purchase directors and officers, or D&O, liability insurance. These policies have very specific provisions relating to coverage. A careful advance reading of a D&O liability policy is always in order.
In addition, the small business owner should be aware that a limited liability company (LLC) will require a specialized policy that applies to "managers" of the LLC, rather than to directors who manage a conventional corporation.
Similarly, a statutory close corporation, which is usually managed by the shareholders rather than by a board of directors, will require a specialized policy that covers the shareholders while acting in their capacity as managers of the entity.
Both the LLC and statutory close corporation also may have officers who are selected from among the managers. It is important that coverage is extended to these officers while they are carrying out their specialized roles.
A D&O liability policy usually is a claims-made policy, covering only those claims made during a policy period. A policy that covers any occurrence during the policy period usually is the best type of coverage, but it may only be offered at a higher premium, or not at all. Where an occurrence-based policy is available and it is not cost-prohibitive, the occurrence-based policy usually will be the better choice (see the discussion of claims-made vs. occurrence-based policies in the context of errors & omissions (E&O) insurance).
A D&O liability policy normally will be limited to the individuals who are named in the policy. Thus, caution must be exercised to ensure that each director, officer or manager is properly listed, and that new parties are added or deleted when there is a change in the management of the business.
The entity itself, its managers, subsidiary entities, and managers of subsidiaries usually can be listed as covered parties under the same policy. Of course, a separate entity may alternatively decide to take out a separate D&O liability policy. This usually makes sense only when management of the entities is not overlapping or the insurance company requires separate policies. If a single policy is used, it is always wise to review the policy in advance to ensure that each entity and its managers are covered.
Indemnification of Officers, Directors and Managers. An operating agreement for an LLC or statutory close corporation (or bylaws for a conventional corporation) generally should include an indemnification clause that requires the entity to reimburse the managers for any liability they personally incur while carrying out their management duties. Generally, state laws allow indemnification, except to the extent that the manager's conduct was a willful violation of the law. Business-friendly states, such as Delaware, allow for extremely broad indemnification of owners.
The clause will add an extra layer of projection for managers, in addition to the D&O liability policy. Of course, when an indemnification clause is triggered, the entity itself pays the damages. The D&O liability policy will mean that the loss will not have to be borne by the entity, provided of course, that the entity is a named party on the policy.
D&O Policy Exclusions. Exclusions in a D&O liability policy can be significant. Therefore, read the proposed policy thoroughly. Common exceptions include:
- bodily or personal injuries
- intentional or criminal violation of laws
- "ultra vires" acts (i.e., acts outside of the scope of the manager's authority)
- liability assessed by a regulatory agency
Each business is unique. In some highly regulated businesses, for example, managers may face their greatest exposure to liability from actions taken by state or federal agencies. If a significant form of exposure to liability is excluded (e.g., liability assessed by a regulatory agency), request that the policy include an endorsement adding coverage. Clearly, the cost of the endorsement must be weighed against the cost engendered by the risk itself.
Finally, D&O liability polices sometimes exclude defense costs from coverage. The duty to defend is important. Therefore, make sure that the policy includes a duty to defend clause.