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Personal Liability for Directors and Officers of Private Corporations

Surprisingly, few directors and officers of privately held corporations fully understand their personal liability exposure as interpreted by the courts. Directors and officers’ personal assets are at risk from these suits that may contain allegations such as fraud, antitrust, unfair trade practices, defamation or breach of contract. Usually directors and officers will have indemnity provided by the company for amounts that they are held liable. However, indemnification is not always available. Indemnification can be limited for reasons such as financial insolvency of the company and may be prohibited by law or indemnification provisions, and/or contrary to public policy or statutory limitations.

The majority of the suits against directors and officers are not brought by shareholders. The 1997 Wyatt Survey reported that 45% of suits against directors and officers of privately held companies are, in fact, employment related. Allegations of wrongdoing are many and varied, with the only limitation being the imagination of the accuser. Some of the obvious include: breach of duty, mismanagement, conflict of interest, self-dealing, conspiracy, discrimination, etc.

As for shareholder claims, just because the corporation is not publicly traded does not mean that it has not issued a "security" that is subject to U.S. securities laws. In fact, directors and officers of privately held corporations owe the same duties to shareholders as do their counterparts at publicly held corporations. It can even be argued that directors and officers of privately held corporations are more at risk of claims because they simply do not have the same resources as large publicly held companies, so that their decisions are made without full or accurate information.

The question is, why expose the personal assets of one’s self, one’s spouse and one’s estate to risk of uninsured loss when there are affordable insurance products available that can minimize the risk of having to pay for such a loss?

Key areas of concern

Employees

Allegations arising from employees against directors and officers have been dramatically increasing over the past few years. This is especially true with regards to employment practices issues such as wrongful termination, discrimination and harassment. While we recommend that every company protect itself financially with an Employment Practices Liability Insurance policy, it is important to note that a Directors and Officers Liability Policy can provide protection against these types of allegations for the individual directors and officers as well.

Shareholders

Consideration should be given to the number of shareholders or debt holders of the private company and the amount of the dollars invested. Obviously, the more stock that is held outside of the founders and insiders, the greater the risk of litigation.

Merger and acquisition activity can also give rise to distinct securities claims, allegations of fraud, and various contractual liability issues. Anytime a valuation is made there are always grounds for a challenge. These challenges frequently occur just prior to an entity’s IPO or merger. Additional shareholder litigation can arise from situations such as private placements, hostile takeovers and failure to complete an IPO.

Strategic Partners/Distributors

Directors and officers of privately held corporations face claims by any party with which the corporation contracts or even discusses a contractual relationship. The strategic partner or distributor creates numerous exposures to just such suits in addition to allegations of unfair business practices. Because many contracts and other negotiations for privately held corporations are handled by officers of the company, officers are personally at risk for claims arising out of these negotiating activities.

Intellectual Property

Claims made against directors and officers for copyright, patent and trademark infringement are ever increasing. In addition, it is not uncommon to see allegations of wrongdoing against directors and officers that involve the hiring of competitors’ key personnel and the proprietary technology or information that follows.

Government Agencies

Claims of environmental contamination to employee health and safety are being brought by government agencies directly against the directors and officers of privately held companies. Violations of regulatory acts, monopolistic behavior, and numerous other charges are all issues that can create additional liability for the company and directors and officers as individuals.

Potential Allegations

Bolton & Company has identified some of the problem areas deserving of special attention by the directors and officers. The following list of words and phrases is offered to prompt consideration of certain duties and potential liabilities.

In Conclusion

It is critical that directors and officers of privately held companies understand their personal exposure to executive liability. Defending allegations of this nature is not a pleasant ordeal and is one that you do not want to take on alone.

One of California’s most respected corporate attorneys, Mr. Michael Rossi from Troop Meisinger Steuber & Pasich LLP, declares that "any director or officer of a privately held corporation who does not insist the corporation carry some form of D&O insurance is playing a dangerous game with high stakes for him or her, his or her spouse, and his or her estate."

The bottom line is that if you carry Directors and Officers Liability Insurance, you can afford to have expert legal defense. Unfortunately, with no coverage, the corporation and its shareholder owners/operators often struggle with the litigation and settlement costs that they cannot afford.

Due to market conditions, the cost of Directors and Officers Liability Insurance for privately held companies has never been more affordable. Unfortunately, however, the risks of allegations and suits have never been more prevalent. Bolton & Company welcomes a discussion with you and your directors and officers regarding these issues and the solutions to them.

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