I’ve been sued as a board member too many times over the past twenty-five years of board service. Five times. Does that shock you? It does me. Entrepreneurs blaming their board for failures of a fragile, early stage company. Shareholders unhappy over the same loss, reaching out to sue every name available. Employees reaching out to anyone above to redress grievances. In one case, an aggressive lawyer finding all the members of an LLC, and suing every member found. Whew!
Whenever there are outside shareholders or note holders, or unhappy employees, and when there is a product in release, there is a chance, no matter how slight, of a lawsuit against members of the board as well as against the corporation itself. Even if such a suit is completely without merit, the cost of defense and the risk of a negative outcome both hang over the company and the director.
Directors and Officers insurance (D&O) is meant to reduce that risk and provide for the legal defense of any such suit at the expense of the insurance company. In that regard, even the lowest amount of D&O insurance available, $1 million, provides for legal defense costs to be covered. The usual cost for such insurance is $4 to $6 thousand a year, with an extra $2 thousand for an additional million dollars of coverage.
[Email readers, continue here…] Recently, insurance companies have added employment practice liability insurance (EPLI) to the package to address specifically the recently-increasing risk of employees suing for redress. Given the increasing number of suits for sexual, racial, gender and other discrimination, this now seems logical and necessary. So, add another $3 to $4 thousand to the policy cost. Ouch!
More important than the cost is the provision of investment documents from sophisticated investors like VC’s and sophisticated angels requiring D&O insurance for the company at the time of funding.
Additionally, I have always insisted that a company CEO sign an indemnification agreement, which indemnifies the director in any event of a lawsuit using the full financial resources and staff capabilities of the company. This may sound harsh, but in reality, the insurance obtained does this. However if a policy lapses and is not renewed, and if the directors are not informed, this agreement forms an underlying defense backed by the corporation. Unfortunately, there are times when early stage companies just run out of money and cannot renew their policies and therefore have little resources to pay lawyers for defense of claims. And unfortunately, it is often during these stressful times that shareholders are angered by perceived or actual under-performance by founders and boards.
Over the many years of board service, before insisting upon this insurance requirement before service, I had been sued as a director several times, in no case covered under the umbrella of a D&O policy. Although I won each of these rather spurious suits, the cost of defense in some of the cases was not reimbursed, and the time spent in helping the attorney prepare for the defense and in one case through to a several-day adjudication event, was not small. As a result, I now insist upon D&O insurance for every board upon which I sit. The backgrounds of these suits make for good stories – for another time.