Liability can exist for officers and directors when they cause financial harm to the corporation, act solely on their own behalf and to the detriment of the corporation, or commit a crime or wrongful act. Certain acts may subject an officer or director to personal liability and other acts, although they would otherwise subject them to liability, may be either indemnified by or insured against by the corporation.
Personal Liability of Officers and Directors
Officers and directors may be personally liable for financial harm caused to the corporation if they:
- Breach their duty of care to the corporation
- Breach their duty of loyalty to the corporation
- Misappropriate a corporate asset for personal use or use by another business
- Commingle personal and business assets
- Fail to disclose potential or actual conflicts of interest
Indemnification of Officers and Directors
Indemnification of officers and directors means that the corporation will reimburse them for expenses incurred and amounts paid in defending claims brought against them for actions taken on behalf of the corporation.
States have recognized that without some method to limit the liability of officers and directors for claims brought against them, it would be difficult for corporations to find anyone willing to serve as officers or directors. As a result, most state corporation statutes now contain provisions regarding indemnification and insurance for officers and directors. However, the provisions vary as to where and when indemnification will apply. Make sure to check your own state's law on this issue.
You can include a provision for the indemnification of officers and directors in your bylaws. Read Bylaws of a Corporation for more information on what role these rules play in a corporation.
Directors' and Officers' Insurance
Insurance policies can cover matters that cannot be indemnified under state law or in instances where the corporation does not have the financial resources to pay for the indemnification. Most state corporation statutes allow corporations to purchase insurance to cover matters resulting from acts taken by officers and directors. Check your state's Business Corporations Act to determine what type of insurance you may purchase for your officers and directors. Directors' and officers' insurance is separate from and in addition to the general liability insurance you purchase for your corporation -- and it is not cheap.
The cost for directors' and officers' insurance has gone up dramatically and the exclusions for coverage have also increased. It's a good idea to speak with an insurance broker regarding the insurance needs and requirements of your corporation. And be sure to read the Checklist of Issues to Review for Directors' and Officers' Insurance.