Protecting your advisory board: uncertainty over liability exposure means that liability may exist, so various protections for an advisory board are still necessary.
Questions abound about the right of a company to establish an advisory board or an advisory committee, and about the purpose of such a board or committee. Does the standard board of directors have the authority to establish a separate advisory board for their own use? Can they, should they, or do they delegate responsibility to this advisory board? For individuals asked to serve in this advisory capacity, can they find protection from liability, either from the companies that they serve, or from insurance?
For many companies that establish advisory boards, or an advisory committee, the value of such additional advice is to have a separate, objective sounding board that can provide information and respond to ideas, without formal management or board responsibility. Smaller private companies, or family-owned companies, may establish advisory boards made up of the various advisers the company may retain for different purposes. This might include outside accountants, attorneys, major clients, bankers, vendors, or others. Certain industry sectors are also more likely to establish advisory boards or advisory committees, although these may function more as honorary roles (without compensation).
For certain jurisdictions outside the U.S., separate advisory boards entirely unaffiliated with the company may be considered mandatory. Public companies might establish advisory boards in response to a specific issue or event. For example, a company that has determined to expand on its diversity hiring might gather together individuals who are deemed to be high profile and to be well known for diversity issues. Sometimes, these types of advisory boards have limited life spans.
In considering whether to serve on an advisory board, most individuals are interested in knowing the degree of their potential for liability and the degree of protection available to them for their service in such capacity. First, are they entitled to indemnification from the companies that they serve? This is an important question because many companies that have established rights to indemnification have probably focused solely on directors and officers. Indemnification may extend to employees. It is less likely that companies automatically cover others, including agents or advisers.
To its directors, officers, and pertinent others (such as advisory board members), an organization's ability and willingness to indemnify them for liability is crucial to their willingness to serve the organization. While the limit of this promise is conditioned by the law of the state where the organization is incorporated or domiciled, most organizations include broad indemnification provisions in their charter, certificate of incorporation, or bylaws, demonstrating their commitment to protect their executives. Indemnification language contained in a company's bylaws or articles of incorporation may look something like that reproduced in the accompanying box (see page 36).
In addition to indemnification that may be granted pursuant to an organization's bylaws or articles, some companies enter into individual indemnification agreements, either as part of an employment agreement or simply as a separate contractual document. In such an instance, the individual entering into the agreement will often feel more specifically protected because the document expressly applies to him or her.
State Corporation Statutes
As a general matter, organizations adopt indemnification provisions that are at least as broad as those allowed under state law in the state where they are incorporated. Even if no indemnification provisions are adopted by the organization, certain individuals are still entitled to indemnification pursuant to the state's corporate indemnification statute. State corporation laws differ from state to state, but many are modeled on the Delaware Code.
Section 145 of Title 8 of the Delaware Code provides for indemnification of "officers, directors, employees and agents" and allows for the purchase of D & O insurance as well. The provisions of the Code set forth instances where indemnification is permissible and where it is mandatory. The Delaware Code specifically applies to directors, officers, employees, and agents. Some state codes reference only directors and officers, so it is important to review the state code where the company is domiciled to determine the scope of state-mandated indemnification.
Under the Delaware Code, the question becomes whether advisory board members fit within the category of "agents" in order to trigger protection under the state indemnification statute. In those states that refer only to directors and officers, there may be no recourse to or protection granted by state corporation laws. For this reason, it is all the more important to understand what protection the company gives, and to understand what protection may be available from insurance.
D & O Liability Insurance
Directors and officers liability insurance is specifically designed to protect individual directors and officers for acts in their capacity as such that result in claims against them. D & O insurance policies are not standardized, so it is important to review the terms and conditions of the actual insurance policy in place to determine the amount of coverage, if any, afforded to advisory board members.
Typically, the insureds covered by the policy may include "Directors and Officers" or alternatively, "Individual Insureds" or "Insured Persons." In any of those instances, directors and officers are typically defined as "duly elected or appointed directors and officers." In the last several years, D & O insurers have attempted to recognize different corporate structures that may exist, and have amended the definition of "Directors and Officers."
In order to ensure that coverage exists for advisory board members, coverage must be specifically requested. In connection with that request, the entire advisory board should be identified as such in the application for D & O insurance. The information provided to the insurance carrier should include a description of the purpose of the advisory board--what it was constituted for and the anticipated length of its existence--as well as identification of its members.
It is not recommended that the actual list of advisory board members be attached to the policy, as that will not protect those who join later. It is also possible that the advisory board members do not want their names specifically attached to the policy by endorsement--out of concern that making them known might make them a target where they were not before.
The advisory board can be added to the definition of insureds by endorsement without further specificity. However, adding this coverage should specifically limit the extension of coverage to advisory board members only when they are acting in that capacity. Claims against an advisory board member for acts committed in his or her capacity as an executive of another company should be covered under that other company's D & O policy.
D & O policies also typically cover individuals for damages or loss that the individuals are legally liable to pay. It is an open question whether an advisory board member has or should have any legal liability for acting in the advisory capacity. While the board of directors that constituted the advisory board may have liability for improper delegation of responsibility, if the advisory board is not legally recognized, it may not be legally liable. Of course, this uncertainty over liability exposure means that liability may exist, so protecting against liability is still necessary.
Policy Coverage Considerations
D & O policies contain certain exclusions that might operate to eliminate coverage for advisory board members. It is important to understand that by adding advisory board members as insureds, claims by them (regardless of capacity) will no longer be covered by the policy. This is due to the presence of an insured versus insured exclusion that provides that claims brought by one insured against another insured are not covered, regardless of what they allege or the capacity in which they bring the claim.
This also means that if the board of directors establishes an advisory board, seeks certain input from them, and then later feels that the advisory board misled or misinformed them, the company does not have any insurable recourse against the advisory board members. On the flip side, if that scenario were to occur, the advisory board would not have any protection from insurance, either.
Adding advisory board members as insureds to the D & O policy also means a potential further dilution of the D & O limits. The more insureds there are under the policy, the greater the possibility of triggering coverage and spending the limits.
If advisory board members are added as insureds, then a claim solely against one or more of the advisory board members can erode or even completely exhaust the entire D & O limits, so that there is no coverage left for the traditional directors and officers. It is possible to address this by adding coverage for advisory board members only when a claim against them also includes one or more other insureds (such as directors or officers). This is referred to as co-defendant coverage and is often used when adding coverage for employees. Another possible way to protect against significant erosion of the policy proceeds by claims against the advisory board is to provide this coverage expansion but with a specific sub-limit so that such claims cannot entirely spend the D & O policy. For example, if the company purchases $20 million in D & O insurance, add coverage for the advisory board members but provide only $5 million of coverage specifically for them.
Triggering a Claim
One of the biggest touch points on a D & O policy is the "claims made" feature of the policy and its strict notice obligation. Being a "claims made" policy means that the D & O policy provides coverage for claims that first arise during the term of the policy. It is not primarily a matter of when the alleged wrongdoing occurred, but of when the claim is "made." Equally important, notice of the claim must be given within the parameters set forth in the policy. In the context of providing coverage to advisory board members, it is important to relay information to them about the "claims made" feature of the policy and the notice requirements. Members must understand that the company itself has to be notified of claims on a timely basis to enable it to forward claims to the insurance carrier within the policy's required time frames.
When individuals who are not executives within the company or directors expressly serving the company are insured and can trigger coverage, the directors and officers of the company may lose some degree of control over the insurance. Once identified as an insured, an advisory board member can directly contact the insurance carrier, file notice of claims, and seek reimbursement of defense costs out of the policy proceeds. While the company can attempt to guard against this by expressly indicating that the company is responsible for providing notice of claims and negotiating coverage, this is not bulletproof.
Need for Assurance
Overall, advisory board members can serve a useful function to an organization and its directors and officers. Unless specifically addressed, however, it is debatable whether there is any actual protection for those advisory board members from the company's internal indemnification provisions, from state corporation statutes on indemnification, or from D & O insurance. It is likely that individuals asked to serve as advisory board members will seek some assurance of protection from the company making the request. Hopefully, the counsel expressed in this article can be useful.
Potential contributions of an advisory board Consensus as perceived by 200 CEOs of leading growth companies 1 Sounding board 88% 2 Strategy setting 69% 3 New ideas 69% 4 Management issues 66% 5 CEO mentoring 63% 6 Management mentoring 34% 7 Business contacts 31% 8 Business and competitive intelligence 31% 9 Executive recruitment 22% 10 Investment contacts 22% 11 Training for formal board of directors 22% 12 Direct investments 9% 13 Other 9% Source: Queen's Centre for Enterprise Development report on "High-Performing Advisory Boards" (www.qced.com). Note: Table made from bar graph.
Terms of indemnification
To the fullest extent permitted by law, the directors and officers [or, even better, the individuals] shall have no liability of any kind or nature with respect to their conduct in serving the organization or any of its subsidiaries, their respective securities holders, or another enterprise at the request of the organization. However, this shall not apply and the directors' and/or officers' [individuals] liability shall not be eliminated for:
1. Any breach of the individual's duty of loyalty to such organizations, securities holders, or enterprises;
2. Any act or omission not in the best interests of such organizations, securities holders, or enterprises, or which involve intentional misconduct or a knowing violation of law; or
3. Any transaction from which any director or officer [individual] derived an improper personal benefit.
Without limiting the generality of the foregoing, and to the fullest extent permitted by law, the directors and officers [individuals] shall have no personal liability to the Organization or any of its subsidiaries, their respective securities holders, or any other person claiming derivatively through the organization, regardless of the theory or principle under which such liability may be asserted, for:
1. Punitive, exemplary or consequential damages;
2. Treble or other damages computed based upon any multiple of damages actually and directly proved to have been sustained;
3. Fees of attorneys, accountants, expert witnesses, or professional consultants; or
4. Civil fines or penalties of any kind or nature whatsoever.
The Organization shall indemnify the directors and officers [individuals] in accordance with the provisions of this Indemnification Clause if the directors and/or officers [individuals] are made a party to any proceeding, against all expenses, judgments, fines, and amounts paid in settlement, actually and reasonably incurred by the directors and/or officers [individuals] in connection with such proceeding if the conduct of the directors and/or officers [individuals] was in good faith and the directors and/or officers [individuals] reasonably believed that their conduct was in the best interests of the organization, or at least not opposed to the organization's best interests, and, in the case of a criminal proceeding, had no reason to believe that the directors' and/or officers' [individuals] conduct was unlawful.
However, no indemnification shall be available under this paragraph if any director and/or officer [individual] is adjudged to have unlawfully profited from the complained-of conduct. In such instance, indemnification may still be available if a court of competent jurisdiction determines, upon application, that despite the adjudication of liability, the director and/or officer [individual] is fairly and reasonably entitled to indemnification in view of all the relevant circumstances.
Source: HRH Executive Risk Solutions
RELATED ARTICLE: Trends in advisory boards
The Sarbanes-Oxley Act has increased the prevalence and profile of corporate advisory boards across America. Coupled with rapid changes in technology, globalization, and market demand, corporate advisory boards are a must-have for a growing percentage of business--from family-owned companies to large multinationals. Leading trends include:
* Advisory Boards for Family-Controlled Companies: Advisory boards can help deal with succession issues and discuss appropriate daily involvement of family members in these businesses.
* Advisory Boards for Nonprofits: Advisory boards can assist with increasing nonprofit credibility in the community and offer fresh perspectives without infringing on the board of directors.
* Global Membership: Companies are increasingly creating international advisory boards to better manage a global consumer base and gain broader perspectives.
* Technology Advisers: Technical advisory councils are a new trend, helping management better understand current technology requirements and define long-term strategic direction.
* Wildcard/Futures Advisory Boards: Advisory boards can help companies anticipate unexpected, wildcard events and help them prepare for the future.
* New Market or Community Advisory Boards: Advisory boards help management be effective globally as well as locally by suggesting new concepts to apply to projects and services.
* Design Advisers: These boards provide an efficient way for firms to get the best and most innovative ideas on form and functionality, packaging, and presentation.
Source: Susan Stautberg, president of PartnerCom Corp., a consultancy that has assembled advisory boards for companies such as Avon, Avis Rent-A-Car, Cigna, and Merrill Lynch, and government and nonprofit organizations.
Susanne Murray, Esq., is executive vice president and leads the Directors and Officers Liability Practice at HRH Executive Risk Solutions, a division of Hilb Rogal & Hobbs, one of the country's largest insurance brokerage firms (www.hrh.com).
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|Title Annotation:||D & O INSURANCE|
|Publication:||Directors & Boards|
|Date:||Jun 22, 2004|
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