Questions to consider
Managing liability risk is a two-way street for organizations and those they invite to serve on their boards of directors. Individuals may feel more comfortable participating as directors when they are less worried about exposure to lawsuits, and nonprofits benefit from the experience and insights that directors can bring when the directors are confident in their decision-making.
Nonprofit organizations tend to have less rigor and structure around risk management than private businesses, and they do not have the reporting requirements of public companies. Therefore, every individual asked to participate on a nonprofit board should raise certain questions:
Does this nonprofit organization have a D&O policy?
Nonprofits commonly purchase D&O liability insurance, but it is critical to understand the quality of the coverage. The D&O policy may be written very broadly to better protect board members, or it could be written with coverage restrictions. It is important to have an experienced insurance professional review the coverage in an effort to best protect the individual director as well as the organization. That said, there are differing types of D&O insurance policies. For example, a Side A policy, which offers coverage solely for the directors and officers, typically sits above a traditional D&O policy and would not provide coverage for suits against an organization itself. It is imperative to understand the policy structure, total amount of coverage, and how the insurance will respond to lawsuits.
What are the policy limits?
Smaller organizations might opt for a minimal level of coverage limits, such as $1 million. At face value, that might seem high relative to a nonprofit’s assets. In reality, $1 million today is not a lot of protection for high-net-worth directors. Even in a seemingly frivolous allegation, defense costs can add up quickly to hundreds of thousands of dollars. It is also important to understand that the limit is typically shared between the entity and the individual directors and officers. All these factors may serve to erode policy limits quickly.
What other risks do nonprofit have that might share those limits?
An advantage of D&O insurance for nonprofit and private organizations is that the coverage is typically very broad. It could respond to a variety of claims, from financial losses to employment practice allegations to third-party liability arising from alleged wrongful acts by management. While the broadness is often beneficial, it could be a negative as well, as the policy proceeds to defend even fraudulent actors until final adjudication, making it important to understand who may be eligible for coverage under the policy and when that coverage may cease. Dilution of limit occurs when the limit available for D&O risk is also used to pay claims on unrelated exposures, decreasing or eliminating the amount of insurance coverage available for the directors or officers.
What is the risk profile of the nonprofit organization?
For directors, a clear picture of the nonprofit’s operations and risk profile is important. Boards are generally viewed as the ultimate risk owners for the organization, and individual directors could make more informed decisions about D&O insurance and indemnification agreements if they better understand potential risks. They must also work to understand the corporate governance and risk-management safeguards in place to protect them as directors and officers outside of the insurance policy. The insurance policy should be a backstop, while sound board practices should be the foundation of director and organizational protections.
What does the nonprofit’s balance sheet look like?
An organization’s bylaws may grant a director or officer defense and indemnity for alleged wrongful acts committed in their role as a board member. In the absence of a D&O policy, this protection comes from the organization’s balance sheet. The D&O policy provides financial backing to the balance sheet for this obligation, and it also protects directors and officers in many cases where the organization is legally barred from doing so. Where a nonprofit balance sheet is weak, adequate D&O coverage becomes more important.
