Planning for D&O lawsuits: 3 tips for reducing risks for directors and officers

Authors:

Arlene Levitin, Esq., Claims Officer, Complex Management Liability, NAS Financial Lines Claims, Liberty Mutual Insurance & Bonnie Hoffman, Esq., Shareholder, Hangley Aronchick Segal Pudlin & Schiller

Inflation rates recently hit their highest levels since the early 1980s, and the economic effects have negatively impacted companies’ operations, financial results, and share prices. And with the Federal Reserve continually raising interest rates, consumers are cutting back on spending, causing stock prices and earnings to drop. When financial conditions are poor, public companies are particularly at risk of a class action securities lawsuit, with claimants alleging that company directors and officers misrepresented projections.

It’s not all bad news, though. Rallying critical financial and risk leadership — together with a trusted insurance partner — can give businesses time to analyze and adjust to changing economic conditions, helping to reduce the chances of a devastating lawsuit. In this article, we’ll examine potential claim risks and explore how careful planning can help mitigate them.

Bring the team together to help assess variables proactively.

The first step in any risk assessment is gathering stakeholders to share expertise and fully understand a business’ problems. Let’s dive into three tactics companies should use to assess and plan for financial shifts.

1. Stay informed.

Knowledge about the economic climate is vital for strategic planning and decision making. Companies that anticipate economic trends are likely to be better positioned to avoid potential threats. Risk managers and internal financial planners should continually monitor external forecasts, especially within their own industry. Being aware of events impacting other companies, too, can help identify areas in your own organization that may benefit from more attention.

2. Cultivate community.

Dealing with inflation and lawsuit risk is a complex task that requires collaboration across different areas of expertise. Bringing together key figures such as fiscal leaders, risk managers, attorneys, brokers, and insurance partners enables businesses to pool their knowledge and understanding to manage these risks effectively. Each stakeholder offers a unique perspective on the risks and can contribute to developing robust strategies to address them. Additionally, this collaborative approach encourages shared ownership of risk, helping to ensure everyone is committed to risk management.

3. Keep communication open.

Each department within a business may face different risks, and being open and proactive about challenges encourages collaborative problem solving. Consider regular meetings or communication platforms where staff can share updates, discuss trends, and highlight potential issues. Sharing information across the business can also help to identify interdependencies and shared risks that may require attention at the board level. As a bonus, fostering a culture where employees feel comfortable voicing their concerns or ideas can also lead to innovative mitigation tactics.

Remain proactive with insurance coverage.

Complacency has no place in risk evaluation. Regularly review your coverage with a trusted insurance partner to ensure it still meets your needs, particularly considering the broader economic environment. If there are areas of uncertainty, your broker can help evaluate and problem-solve — understanding precisely what your policy covers can help avoid unpleasant surprises in the event of a lawsuit.

Additionally, you can evaluate together whether there are additional insurance products or adjustments to your current policy that could provide further protection against inflation-related lawsuit risks. Some potential important clauses include:

Fraud exclusions

Almost all directors & officers (D&O) insurance policies contain a fraud clause that could be relevant to securities lawsuits. However, the simple accusation of fraudulent behavior doesn’t necessarily activate the fraud exclusion. In most insurance policies, a confirmed demonstration of fraudulent behavior — a final judgment confirming the behavior — is needed for the exclusion to take effect. Your insurance broker can help suggest policy clauses that may still safeguard against accusations of fraud.

Nonimputation clauses

These clauses are sometimes, but not always, included in D&O policies. They essentially help prevent the knowledge, actions, or inaction of one insured person from being attributed to another insured person. This means that if one director or officer acts wrongfully or fails to disclose relevant information, the other business leaders — or even the organization as a whole — won’t automatically be penalized in terms of coverage.

Side A coverage and bankruptcy

Side A coverage is designed to protect individual directors and officers. This coverage specifically applies when directors or officers are personally sued and the organization is legally unable or unwilling to indemnify them. Side A coverage is helpful if the company is insolvent or bankrupt, legal regulations prohibit the company from indemnifying the directors or officers, or the company’s bylaws or charter do not allow indemnification in a specific circumstance. In these situations, Side A coverage may cover the legal costs, settlements, and judgments against the individual director or officer.

Liberty Mutual will show up as a trusted partner.

It’s crucial for any director or officer to understand what their D&O insurance policy covers, and working with a reliable broker can ensure all parties understand potential pitfalls. The ideal situation is avoiding litigation altogether, but leaning on a dependable insurance provider proactively can help a company or its leaders in the event that they have to contend with a lawsuit.