Directors and Officers Liability

Officer’s Duties

Directors and Officers of private corporations have specific duties and are personally liable for the breach of these duties. The breach of these duties is the fundamental source of D&O claims. There are three basic duties:

Duty of Care

A director’s or officer’s duty of care is broad and is defined by each state’s corporation statute. It typically requires duties to be performed "with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances." The Business Judgment Rule is often applied to directors to determine whether a duty of care has been fulfilled.

Business Judgment Rule

"A director who exercises reasonable diligence and who, in good faith, makes an honest, unbiased decision will not be held liable for mere mistakes and errors in business judgment." Interpretation of this rule varies by the expertise, experience and role of each director, the state and the specific facts of each situation, but the Rule is intended to protect directors from liability from suits resulting from bad business decisions that were reasonably and diligently made.

Duty of Loyalty

A director is a fiduciary of the company and this fiduciary relationship creates the duty of loyalty. A fiduciary relationship requires that each party may not take advantage of the other’s trust, and may not take advantage of the relationship to the disadvantage of the other. The duty of loyalty requires that the director must perform his or her duties in good faith and in a manner which he or she believes is in the best interests of the corporation and its shareholders. The director (and officers as well) must not take advantage of a business opportunity (a "corporate opportunity") without first giving the corporation the opportunity to take advantage of the business opportunity.

Conflicts of Interest

A conflict of interest is a situation or transaction which influences a directors or officers judgment, particularly in a manner detrimental to the corporation.

Duty of Obedience

The directors and officers are expected to perform their duties in accordance with the corporate charter and bylaws, and other statutes and requirements, and lack of knowledge is not an effective excuse.

Indemnification

Virtually all corporate charters allow for indemnification of directors and officers for liability. This means that the corporation may reimburse the directors and officers for expenses incurred in defending and settling claims against them arising out of their service to the corporation. Directors and Officers Liability Insurance (D&O) exists to provide financial resources to pay for this defense. One reason to purchase D&O insurance is to provide financial resources to the corporation so it may reimburse directors and officers under the indemnification provisions with no or little financial impact (this is often called "Side B" or "Coverage B" under the D&O policy). However, there are a number of circumstances where the corporation can not reimburse directors and officers for the costs of defending claims. In this situation the D&O policy will respond directly to the directors and officers (this is often called "Side A" or "Coverage A" under the D&O policy). Some of these situations are:

Because of these situations, self insurance of a D&O exposure is not necessarily effective in protecting the directors’ and officers’ personal financial resources. See Protecting Ds & Os Personal Assets.

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