RISKVUE ARCHIVE | INDUSTRY WATCH > NONPROFITS

Directors’ and Officers’ Liability Insurance

By Melanie L. Herman

One of the myths associated with the potential exposure of nonprofit board members is that because nonprofits do not have shareholders, there are few sources of potential claims. But nonprofits serve large and varied constituencies, and nonprofit boards owe specific fiduciary duties to these constituencies in the same way that corporate boards owe a duty to their shareholders. These constituencies are potential plaintiffs in legal actions brought against nonprofit boards. Potential claimants in a suit against a nonprofit include:

1.  Insiders. The current or former staff of a nonprofit may bring actions alleging a host of wrongful acts, such as wrongful termination, discrimination, sexual harassment, or violations of the Americans with Disabilities Act.

2.  Outsiders. Third parties that have a business or other relationship with the nonprofit may allege harm caused by the nonprofit or its directors, officers, or employees.

3.  The entity itself. The nonprofit may bring an action against its directors or officers. One example includes claims by current management against a former trustee. In some states, derivative suits are permitted. In a derivative suit, members of a nonprofit may bring a claim on the nonprofit’s behalf against a director or officer.

4.  Directors. A nonprofit director may sue another board member alleging violation of a duty owed to the nonprofit.

5.  Beneficiaries. The people whom the nonprofit is in business to help (service recipients) may bring claims against directors or officers alleging wrongdoing.

6.  Members. Directors and officers of membership associations are vulnerable to claims brought by members alleging harm to the interests of the member.

7.  Donors. A nonprofit’s contributors may sue directors or officers alleging misuse of a restricted gift.

8.  The attorney general In most states, the state attorney general represents the interests of the general public in ensuring the proper management of nonprofit corporations. As such, the attorney general may bring a claim against nonprofit directors or officers alleging wrongdoing.

9.  Other government officials. Other government officials, including representatives of the IRS or the attorney general for your state, may bring actions against nonprofit directors or officers alleging violation of state or federal laws.

While the potential sources of claims against nonprofits and nonprofit boards are vast, as described above, claims against nonprofits and nonprofit boards remain infrequent. In addition, while nonprofit directors and officers are rarely held personally liable, this determination may not be made until after considerable funds have been spent to defend the directors or officers and the nonprofit.

Every nonprofit board should seek professional assistance before purchasing directors’ and officers’ (D&O) liability insurance. There are many differences in available policies, and no single D&O policy is suitable for every nonprofit. Under a D&O insurance policy, coverage is provided for the defense of actual or alleged wrongful acts committed by a board of directors. As indicated previously, the person filing suit may be an insider, such as an employee or volunteer, or an outsider, such as a service recipient, donor, or government official.

Some of the coverages that a nonprofit board may want to consider include:

• Entity coverage. Entity coverage ensures that the coverage available under the policy extends to the nonprofit as well as to the directors, officers, and others. Entity coverage may be crucial for a nonprofit. A nonprofit is a likely target in litigation brought by a disgruntled employee, service recipient, or outsider. It is also possible that only the nonprofit—and not individual directors or officers—will be named. If this were to happen in a policy limiting coverage to directors and officers, no coverage would be provided for the nonprofit. A board must read its policy carefully to determine whether entity coverage is provided. A logical place to look is in the policy’s definition of “insured.”
  
  
• A broad definition of “insured.” Traditional corporate D&O policies contain narrow definitions of “insured”—limiting coverage to current directors and officers of the corporation. A policy that has been tailored to meet the needs of a nonprofit will contain a broad definition of “insured.” The definition may ensure coverage for the nonprofit (the entity or organization), as well as current and former directors, officers, trustees, staff, agents, and volunteers. A savvy plaintiff alleging injury is likely to name everyone connected to the event or decision in his or her suit. A broad definition of “insured” ensures protection if a defendant falls outside the narrow definition of “officer.”
  
  
• Broad definitions of “claim” and “wrongful act.” In addition to defining who is covered, a policy also defines what types of claims will be covered. Some nonprofit D&O policies provide broad coverage for a wide range of claims. While some policies restrict coverage to “claims for money damages,” a growing number of policies provide coverage for the defense of “administrative proceedings” such as complaints filed with local human rights commissions or the Equal Employment Opportunity Commission. Under a policy that provides such coverage, the definition of “claim” may include language such as “Claim means a civil, criminal, or administrative adjudicatory proceeding initiated against the Insured, or a demand for money damages.”
  
  
• Coverage for a wide range of employment practices. Employment-related claims account for the vast majority of claims filed under nonprofit D&O policies. And while there are many specific steps a nonprofit can and should take to reduce the likelihood of a claim, legal challenges cannot be avoided altogether without forgoing a workforce. Unless an alternative risk financing mechanism has been selected, liability insurance for employment-related actions is a good bet. There are three ways to obtain such coverage. First, it may be available under a commercial general liability policy. Traditional commercial general liability policies specifically exclude coverage for employment-related events, but this is not universal. Second, it may be purchased as a stand-alone employment practices liability policy. Third, it may be included under a D&O policy or available as an endorsement to a D&O policy. Generally speaking, the first and third options are the most affordable.
  
  
• Defense coverage. A primary motivating factor behind the purchase of nonprofit D&O coverage is the desire to have funds available to pay for a defense. Many nonprofits are not in a position to fund the cost of a legal defense, which can be substantial. According to the Wyatt Nonprofit Organization Directors & Officers Liability Survey Report (1993), the average cost to defend a lawsuit runs between $35,000 and $100,000. Do not assume that a D&O carrier will fund a defense. Some policies simply provide indemnity for covered losses, leaving the nonprofit to defend the claim on its own. “Duty to defend” policies are generally considered to afford broader coverage than indemnity policies. This is because under the former type of policy, the insurer may be required to defend actions that aren’t otherwise covered. It is important for a nonprofit to understand which form of coverage it has. Under the reimbursement style of policy, the nonprofit must fund the litigation and wait to be reimbursed after the case has been resolved. Under a “duty to defend” policy, legal expenses are paid on the nonprofit’s behalf as they are incurred.

For more information on D&O insurance for nonprofit organizations, see
D&O: What You Need to Know, available from the Nonprofit Risk Management Center.

ABOUT THE AUTHOR

Reprinted with permission from the Nonprofit Risk Management Center (www.nonprofitrisk.org). For more information on the risks facing nonprofit boards or to discuss any of the issues in this article, contact the author, Melanie L. Herman, at Melanie@nonprofitrisk.org or 202-785-3891.

riskVue | The webzine for risk management professionals
May 2005