Directors and Officers (D&O) coverage protects a company’s board of directors or officers from legal liability arising from their actions or omissions. Broadly speaking, it protects the individuals involved in governing the company when a lawsuit is filed by an employee, stakeholder, or other officer alleging wrongdoing or mishandling by the board member that resulted in a poor business outcome.
"D&O is required in every term sheet, as set forth by the NVCA. Sparx surveyed top venture firms and found only 27% of portfolio companies were compliant with this requirement, leaving founders and their spouses vulnerable to personal liability in a lawsuit."
What does it cover?
D&O insurance includes multiple comprehensive parts to ensure coverage for both the individuals and the company when company mismanagement is alleged. This prevents a founder or their spouse from having to pay out of pocket in the event of a lawsuit.
Used when a director is sued as an individual and pays defense costs out of pocket. Side A will only pay the individual directors and officers if the company is unable to or the company refuses to indemnify the individual, such as if the company is insolvent or the claim goes against the company by-laws.
An additional coverage amount that kicks in if the legal costs of the individual director being sued exhausts the rest of the policy. There will typically be a minimum base layer of A-B-C coverage of $5 million, and sometimes $10 million, depending on the company. Excess of $5 million/$10 million will usually focus on Side A coverage.
When the company indemnifies individual directors named in the lawsuit, Side B coverage reimburses those costs. However, it only extends to indemnifying insured individuals named in the lawsuit.
This entity coverage provides a balance sheet protection for the company named in the lawsuit alongside an individual executive. Such coverage will reimburse the costs and settlements incurred.
Examples of D&O Insurance Claims
The leader of a little-known crypto exchange uses customer deposits to trade currency, leading to a large loss of funds for customers and causes the business to declare bankruptcy. Shareholders and investors came together to sue FTX leadership, alleging mismanagement of the company, seeking a settlement for their lost capital and potential returns. A $10M D&O policy kicked in to protect the CEO from paying out of pocket for these lawsuits, including a specialty fraud clause which is typically excluded from this coverage.
The OpenAI board recently fired Sam Altman, the company’s CEO, with seemingly little reasoning, leading to more than 80% of the company threatening to quit, potentially destroying the company’s valuation overnight. With little reasoning provided, venture capitalists and other stakeholders prepared legal action against the board for this mismanagement that would have minimized their return. While this legal case plays out, D&O coverage will protect these individuals for legal costs and settlements.