There are plenty of misperceptions and marketplace myths when it comes to the need for directors and officers liability insurance, especially for privately owned, emerging and midsized companies.

Three myths in particular are all too common, any one of which can leave directors and officers seriously exposed to high legal costs and potentially crippling damage claims in heavy-duty lawsuits.

Therefore, corporate insurance buyers, along with their agents and brokers, need to be vigilant not to fall victim to the following trio of myths:

The most prominent myth is that privately owned companies don't need D&O coverage--and a number of them believe this. Buyers are convinced that only public companies need D&O insurance to protect the firm's assets, and those of its directors or officers, from shareholder claims.

Moreover, the high-visibility claims made against large public companies--Enron, Tyco and MCI/WorldCom, to name a few--only serve to reinforce this belief.

Compounding the issue, smaller companies tend to think of themselves as "small potatoes" and thus able to fly under the radar of today's corporate litigation.

While it's true that claims against larger public firms are greater in terms of sheer dollars, private corporations have shareholders, too--some with tens of millions of dollars invested and at risk.

These shareholders frequently sue on the basis of inadequate or inaccurate disclosures in financial reports or due to the statements made within placement materials.

Furthermore, private companies are not only sued by shareholders--they are also vulnerable to the claims of lenders and creditors, customers and regulatory agencies. In disputes with these third parties, a lawsuit is often pursued as the only available recourse.

Here's an example:

An investor sued a manufacturing company--alleging financial misrepresentation, among other things. The investor charged the firm with making false representations regarding the forecasted rate of growth and failing to disclose significant liens against the company.

When the company defaulted on the loan, the investor issued a demand letter and filed suit against the company.

The demand letter stated that they never would have invested had they known the full extent of the company's financial position. Although the investor eventually agreed to accept an offer to convert the promissory note to stock in the company, the defense bill exceeded $90,000.

This shows how costly misrepresentation of financials can be, even if the misrepresentation is accidental. Fortunately, however, the manufacturing company was covered for these expenses under the D&O section of its policy.

Another marketplace myth is that personal assets are safe from the actions and decisions made on behalf of a company, because it's a corporation. Many directors and officers of private companies mistakenly believe their personal assets are safe from litigation against their corporation.

While they believe the barrier between professional actions and their personal assets is completely secure, they are wrong! Third-party lawsuits from creditors--shareholders, customers and vendors, or others--can name individual directors and officers in their claims, exposing personal assets to potential loss.

While many have some of their information correct, they still believe their company will fund a legal defense on their behalf and will pay for any subsequent judgments. Unfortunately, this is not always the case. The reality, however, is that there are multiple reasons why a company will not or cannot indemnify its directors and officers.

Bankruptcy is the most common scenario--because of how it limits the amount of funds available to protect directors and officers, leaving them to fend for themselves. This was the case with a firm that obtained a $500,000 bank loan, secured by the capital equipment used to manufacture its product.

Shortly after drawing down the funds, the company filed for bankruptcy. The bank subsequently learned that the equipment had been pledged as collateral to a materials supplier and the bank would likely have to write down the entire loan.

The bank brought personal claims against the chief financial officer, chief executive officer and general counsel, as well as the corporation for failing to disclose and misrepresentation of its financial condition. What's more, D&O insurance could have covered this type of exposure.

The third marketplace myth is that only larger firms can afford D&O insurance. For all of the reasons stated in the first two myths, however, emerging and middle-market firms can't afford not to have D&O insurance.

To improve affordability and for greater ease in management, D&O policies can be bundled with other coverages--such as employment practices, fiduciary liability and crime. Bundled policies usually allow for shared policy limits at a discounted premium.

In other words, the more coverages purchased on a shared limit basis, the more premium credits there are available to apply. Bundling provides a more sensible and economical way for firms on tight budgets to purchase the coverages they need at the best possible rates.

Additionally, bundled packages are easier to administer, given that there is usually only one policy form to fill out and one effective date. Not having multiple effective dates to track--as is typical with separate policies for each type of insurance--reduces the risk of a lapse in coverage.

In addition, bundled packages are ideal for small to midsized companies lacking the resources to employ a full-time risk manager to manage their insurance needs.

Whether a company is small or large, private or public, the question is not if it will be sued, but when! And as a risk manager, you want to be sure your company is personally protected.

Special Reports /

Trio Of Misperceptions Can Leave Directors & Officers Exposed To Lawsuits

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