Many private companies mistakenly believe that directors' and officers' (D&O) liability insurance is unnecessary, often assuming that the only significant source of liability for directors and officers stems from disgruntled shareholders. However, it is crucial to recognize that lawsuits filed by shareholders represent just a fraction of the lawsuits that can be brought against directors and officers.

In reality, there are numerous exposures that present potential liabilities to the personal assets of directors and officers of privately-held organizations. These liabilities can extend to the personal assets of their spouses and estates as well. It is important to note that D&O lawsuits can be initiated by various parties, including employees, customers, creditors, vendors, competitors, and regulators. These exposures exist irrespective of the number of shareholders or whether the company is private or public.

Who sues private companies and why?

Claims by customers, clients, and consumer groups: 

Common allegations encompass a wide range of issues, including but not limited to harassment, discrimination, violation of civil rights, contract disputes, misleading statements and false advertising. In addition, it is important to note that clients can also become claimants if the company experiences financial impairment.

Claims by competitors, suppliers, and other contractors: 

Typical allegations often include a range of legal issues, such as anti-trust violations, unfair competition leading to lost business for competitors, and infringement of patents, trademarks, and trade secrets.

Claims by employees: 

Claims alleging harassment, discrimination, and wrongful termination can be directed towards both the company itself and its directors and officers. A well-designed Directors & Officers policy includes employment practices claims.  This coverage is also available with most carriers as a separate coverage part under Employment Practices Liability.  

Claims by other third parties: 

Claims vary from those relating to environmental contamination to employee health and safety. Moreover, privately held companies can also face investigations and claims from certain regulatory agencies such as the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ), particularly in cases involving suspected or proven wrongdoing.

Claims by shareholders/lenders: 

Private companies can face lawsuits initiated by private shareholders, bondholders, investors, or lenders. These legal actions often revolve around allegations of misrepresentation and inadequate or inaccurate disclosure in the financial reporting of private placement materials. Since the availability of a private company’s financial date is limited, these stakeholders heavily rely on the information and statements provided by the company. 

In addition to misrepresentation claims, there are other examples of shareholder claims that can impact private companies. These include:

• Breaches of the duty of care: Shareholders may allege that directors and officers failed to exercise due care in handling the sale of the corporation or missed out on significant business opportunities that could have benefited the company. 
• Breaches of the duty of loyalty: Shareholders may raise concerns about deals or transactions entered into by the corporation with companies owned, either wholly or partially, by one or more directors and/or officers. 

Mergers and acquisitions (M&As): 

In the context of mergers and acquisitions (M&A), private companies can take on the role of buyers or sellers. In such transactions, D&O insurance plays a crucial role in providing protection against potential claims. These claims may include:

• Disgruntled shareholder suits: Shareholders may initiate legal action, alleging grievances related to the M&A transaction.
• Alleged financial misstatements or misleading statements: Claims may arise from accusations of inaccurate or misleading statements regarding the company's revenue sources or market share during the M&A process.
• Failure to perform appropriate due diligence: Claims can result from allegations that the company failed to conduct thorough due diligence when engaging in the acquisition, potentially leading to financial or operational issues.
• Bankruptcy resulting from a failed transaction: In cases where an M&A transaction fails and leads to bankruptcy, claims may arise from various parties involved in the process.
• Claims from past creditors and/or vendors of the acquired company: Creditors and vendors associated with the acquired company may assert claims against the acquiring company, seeking compensation or resolution for past obligations.

Succession planning and corporate governance: 

Many private companies are managed by individuals who are closely involved in the day-to-day operations, often including the founders and their families who hold ownership stakes in the company. This close involvement can give rise to several challenges, such as:

• Proxy disputes: In situations where founders are forced out of their leadership roles, conflicts may arise regarding control and decision-making within the company.
• Legal disputes among family members: When family members are part of an ownership trust and involved in the company's operations or potential transactions, disagreements can occur, leading to legal disputes.
• Inadequate succession planning: Poor planning for leadership succession can result in leadership vacuums or disputes when there is a sudden change in leadership due to unforeseen circumstances like illness or death.

It is essential for private companies to understand the broader scope of potential liabilities and the need for comprehensive D&O insurance coverage. By recognizing the diverse range of risks faced by directors and officers, companies can protect their leadership and safeguard their personal assets from potential legal challenges.

To learn more, email private.us@victorinsurance.com or connect with your business development contact.