Corporate directors are becoming increasingly attractive targets for lawsuits these days, particularly when a company's fortunes, for whatever reason, turn sour. That has forced many smaller companies to make a hard choice: either pay steep rates for directors' and officers' liability insurance -- if they can get it at all -- or leave their top executives and directors unprotected.
But Western Employers Insurance Co., in conjunction with the National Association of Corporate Directors (NACD), has begun to offer a comprehensive, low-price D&O policy that caters specifically to the needs of small and emerging companies. There are just two catches: The entire board must become NACD members for $150 per director per year, and, for companies less than four years old, the chief executive officer and one independent outside director must complete a two-day NACD seminar on the role of the director. Within a year, the rest of the board must also attend the seminar.
The availability of D&O coverage for small companies gives them much wider latitude in recruiting directors and top officers. For instance, William Chisholm, president of Boardroom Consultants Inc. in New York City, a consulting firm specializing in matters concerning boards of directors, will not recommend that a candidate serve on a board without such coverage. "I don't think any intelligent person would sit on a board at such risk," he maintains.
The risk can be sizable. When the Hamilton National Bank of Chattanooga filed for bankruptcy in 1976, the bank's board of directors got slammed with a huge civil lawsuit holding the board members personally liable for losses brought about by the bank's failure. Ironically enough, the bank's board chairman and the officers of the holding company that owned the bank, in a money-saving move, had failed to renew the company's D&O policy, which had become due just before the bankruptcy.
"One of the great imponderables of business history, that," said Gordon P. Street Jr., and outside director on the board at the time. Along with the other members of the board, Street discovered the lack of insurance coverage when it was too late. He and a few other board members settled out of court for $75,000 each. Other board members settled for as much as $125,000. The settlements were based on estimates of what it would cost to defend the case.
Lawsuits have become even more common since then. A 1982 study by the Chicago office of The Wyatt Co., a management consulting firm, showed that in 1974, 14.4% of the companies responding reported claims brought against the companies' directors and officers during the previous nine years. In 1982, 27.4% of the surveyed companies reported such claims. The Wyatt report shows that 42% of the claims were brought by stockholders and 17% by employees.
Small companies must pay the highest rates to protect their directors and officers against such suits. Of the 19 INC. 100 companies that participated in the 1982 Wyatt survey, 14 carried D&O coverage at a cost 25% to 50% more than other companies of equal size and slower growth. "It's one of those things where, as they say, if you get so big and financially secure that you don't need [insurance], then you can buy it," said NACD chairman Joseph S. Chalfant.
For Lawrence Samartin of Flexible Computers Corp., in Dallas, the NACD insurance is important because he can buy it now. "We're a brand-new company -- founded in October, we went public in December -- and I needed insurance to attract board members," explains Samartin, whose company is developing a multicomputer. "At least two that we asked on the board declined the offer; they said they couldn't take the risk and needed to be insured. I did have one other insurance company willing to insure us, but their cost was prohibitive and their coverage restrictive. You might say they were willing to take a risk with us by charging a tremendous amount to cover, well, not much of anything at all. With this [NACD] policy I can get the directors I want, and sleep easy."