(December, 2007)
A corporation’s directors and officers have a duty to manage the company in their stockholders’ best interests. They are bound to use due care and to be diligent in respect of the management and administration of the corporation’s affairs and in the use of its property and assets. Accordingly, they are liable for losses or injuries that are caused by their breach or neglect of duty.
One of the most common and serious kinds of legal actions against a director or officer is a derivative suit. This is a suit in the name of the corporation against the executive, brought by a stockholder for reasons usually involving alleged mismanagement of the company. Directors and officers are also exposed to possible legal actions:
Another important source of claims against D&O policies are shareholder actions involving takeovers, mergers, acquisitions and divestitures. According to the 1991 Wyatt D&O survey, companies with a history of merger, acquisition or divestiture activity were more than three times as likely to experience a claim than companies that did not have such activity.
Recognizing the need to have competent directors and officers on executive boards, many corporations have put in their by-laws or charters certain resolutions undertaking to indemnify their directors and officers for legal expenses incurred by them in defending suits based on alleged wrongful acts in their capacities as directors and officers. Such indemnification provisions are permitted by most states’ laws.
A law enacted in the state of Delaware goes a step further. This amendment of the General Corporation Law of that state provides that: "A corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation against any liability asserted against him and incurred by him in any such capacity, whether or not the corporation would have the power to indemnify him against such liability under the provisions of this section."
Underwriters of Directors and Officers Liability insurance interpret this Delaware law to mean that the state authorizes the corporation to purchase and maintain such insurance, and that the corporation can pay the full premium. If so, it answers the question raised by many who feel that it would be improper for a corporation to pay premium on behalf of its directors and officers because it is against public policy.
Since the passage of the Delaware law, thirty other states have also enacted similar legislation permitting corporations to have the power to purchase and maintain liability insurance covering corporate officers, directors and employees.
The Delaware statute, however, cannot limit the director's liability with respect to certain wrongful acts, such as:
· Duty or loyalty to the corporation or its stockholders
· Intentional misconduct
· Payment of unlawful dividends
· Unlawful stock transactions
· Acts resulting in liability to others outside of the corporation or stockholders
· Violation of federal statutes
· Actions in which injunctive relief is sought.
A broader statute was enacted in Indiana, which details typical standards of conduct for directors and then provides that a director is not liable for any action taken as a director unless he failed to conform to the standards of conduct and the failure to perform constituted willful misconduct. Several states have followed this approach.
Protection varies from state to state. In general, the new statutes do not protect directors from claims brought by governmental agencies, or claims alleging violations of securities and exchange laws or other federal laws.
The Internal Revenue Service has ruled that premiums paid by a corporation for insurance policies indemnifying the corporation against damages sustained for the wrongful acts of its officers and directors in their official capacity and reimbursing the officers and directors for their expenses arising from such wrongful acts, are deductible by the corporation as ordinary and necessary business expenses. Such expenses cannot be included in income of the officers and directors as noncompensatory fringe benefits. The premiums for Directors and Officers Liability coverage are thus considered as paid to meet an obligation of the corporation with respect to the employment of its officers and directors. The premium payments are considered noncompensatory fringe benefits, since the insurance protection afforded by the payment of the premiums allows officers and directors to make business decisions without fear of unfavorable legal consequences. (Rev. Ruling 69-491.)
In July 1976, the Internal Revenue Service also ruled that a business executive who pays his own liability insurance against corporate wrongful acts could claim that expense as a deductible business expense on his income tax return.