Family business owners may assume that D&O insurance coverage is necessary only for publicly traded corporations and large, non-family owned private businesses. That is not the case. Individual directors and officers of a family owned business may be subject to many of the same types of claims as their counterparts at other businesses—claims by employees, disgruntled shareholders, customers, competitors and government regulators.
The first line of defense for directors and officers is indemnification by the corporation itself. Most corporate bylaws (and operating agreements for limited liability companies) contain indemnification provisions under which the corporation may be obligated to pay defense, settlement and judgment costs for individual directors and officers. The corporation’s indemnification, however, is only as good as the corporation’s ability to pay. And in a family-owned business, where a substantial portion of the owners’ personal wealth may be tied up in the business, indemnification by the corporation essentially means family owners making payments out of their own pockets.
Properly structured D&O coverage can help to shift the financial risk of claims to the insurance carrier. In addition, it will be difficult to attract and retain qualified directors and executives from outside of the family unless the corporation has D&O coverage. D&O policies generally contain three types of coverage:
- Side C coverage is coverage for the corporation itself.
- Side B coverage reimburses the corporation for money that it has paid to indemnify individual directors and officers.
- Side A coverage provides coverage for individual directors and officers that are not indemnified by the corporation.
The coverage should be structured to protect both the corporation and individual directors and officers.
Before purchasing coverage, you should carefully review the key policy provisions with your broker or an independent insurance expert. Key provisions include the definition of “claim,” the policy limits, the deductible or self-insured retention amount, and the policy exclusions. As with most insurance policies, D&O policies contain a number of exclusions. Of particular importance to family businesses is the “family exclusion.” D&O policies routinely exclude coverage for claims brought by family members against the corporation or other family member directors and officers. Carriers want to avoid being pulled into family disputes and also avoid collusion between family members to fabricate claims. The family exclusion typically extends to multiple generations and will include shares held in a family trust. If you are concerned about obtaining coverage for potential claims by disgruntled minority family shareholders, you should carefully review the terms of the family exclusion with your broker before purchasing coverage.