What Every Director Should Know About D&O Insurance

When is the right time to revisit your directors and officers (D&O) insurance? It’s a question that many larger cannabis companies grapple with, and we know the topic of cannabis insurance isn’t always fun.

Here’s a simple breakdown of what D&O insurance is, what it does and does not cover, and what you need to know about this valuable policy.

What Does Cannabis D&O Insurance Cover?

D&O insurance protects a company and its executives. This policy is intended for venture-backed companies as well as public and private businesses with high liabilities or a board of directors. Directors and officers insurance covers managing directors, c-suite executives, and anyone else in a leadership role. Also, having D&O insurance is a recruitment and retention tool to help your business have the best quality executive leadership. Prominent board members or executives want to make sure that their personal assets are protected before joining an organization. They want to know that they will not be held personally liable for managing or advising the company and that the organization has a strong D&O program in place.

D&O insurance protects the personal assets of business executives against lawsuits. In other words, D&O insurance helps keep personal assets from being leveraged during a case.

But what does cannabis D&O insurance look like in practice? Most policies have three layers: Side A, B, and C.

Side A

This policy protects individuals and will cover an individual director by paying defense costs or settlement costs resulting from a lawsuit. Side A comes into play when a business is unable to or not legally permitted to pay.

Side B

This policy provides indemnity to the entity after it has paid the individuals named in the lawsuit, so the individuals cannot come back with another suit.

Side C       

This policy protects the entire entity if the entity is named alongside an individual director in a lawsuit. It will cover the business balance sheet and reimburse costs or settlements incurred.

What Does Cannabis D&O Insurance NOT Cover? 

There are several exceptions to a cannabis D&O policy, including:

• Claims covered by other insurance policies, including but not limited to bodily injury, property damage, products liability, pollution, employee benefits and ERISA violations, professional services, contracts, harassment, discrimination, workplace torts, and violation of privacy law.
• Conduct exclusions. This is a behavior exclusion for “bad actors”. Conduct exclusions include any deliberate criminal, dishonest, or fraudulent activity as well as claims involving illegal profits.
• Major Shareholder Exclusion. If a claim is brought against a company or officer by a shareholder who owns a large percentage (typically %10 or greater) of the company and is not a member of the board, D&O policy won’t apply.

How Much Coverage Do You Need?

Companies need customized insurance towers for D&O coverage, ranging from $1 million to $750 million. In a nutshell, it comes down to the risk tolerance of each company and the major shareholder exposures it faces.

Some factors influencing D&O insurance include benchmarks, financials, and coverage endorsements. When building your tower, a practical guide is 2/3 A-B-C coverage with 1/3 Side A. But each company needs a custom tower and the limit structure depends on the organization. The following endorsements are standard on D&O policies.

• Additional Side A limit
• Dilution claims
• Bump-up claims
• Employed lawyers
• Class certification investigations
• Roadshow coverage
• Broad changes in control and M&A provisions
• Pre-arranged ERP pricing

Public D&O insurance isn’t a one-size-fits-all, so it requires more than a glance to determine the right tower for your business. Instead, developing your D&O policy is an intensive, collaborative process that can take up to two weeks.

How Do Companies Achieve Success In Top-Tier Markets? 

Joining the OTCQX and OTCQB markets is no small feat. It requires meeting high financial standards, following best practice corporate governance, regulatory compliance with US security laws, and updated disclosures, to name a few. Achieving success in top-tier markets also requires strategy, focusing primarily on risk management and transparency. Let’s review various blueprints that many OTCQX and OTCQB companies follow:

• Compliance reduces risk. Complying with management liability standards is one of the best ways to avoid D&O litigation. Your leadership team needs to play by the regulator’s rules — full stop. Areas of exposure for directors and officers are broad and can include a host of issues like cybersecurity and ESG for the OTC market. If your leaders aren’t following all the best practices, it increases your exposure.
• Transparency reduces risk. Companies must have clear, honest, and current disclosures. Boilerplate disclosures speak to a lack of interest from the company to the investors, and no one wants to feel unimportant. Transparent and regular conversations with investors reduce risk.
• Keep sales above board. C-suite executives who engage in suspicious-looking stock sales raise eyebrows and can result in mismanagement lawsuits. Consult legal counsel if there’s any doubt about a pending stock sale, and be transparent.
• Understand your risk level. When you know how exposed you are (or aren’t), you understand the areas that need coverage and can purchase adequate management liability protection. If you don’t understand your risk, engaging with the right D&O insurance broker can help. The right broker can be a trusted advisor to directors and officers on your team.
• Get friendly with your insurer. Vetting is a critical stage in finding the right D&O insurer. The vetting process can help you understand a broker’s financial strengths, their claims response history, and ensure the broker understands your business. Speak with the executives on the underwriting team, and ask for past examples.
• Use strategy to select defense counsel when needed. A little vetting goes a long way. Having the right defense counsel when needed is well worth the investment. Quality defense can save you hundreds of thousands of dollars down the road.

Tackling the world of cannabis insurance can be overwhelming and confusing, but it doesn’t have to be when you have the right team on your side. Having the right policies in place in your business is a safety net – you rarely think about it when it’s not needed, but it had better be in place when it is. At AlphaRoot, we’ve helped hundreds of cannabis companies around the country get the coverage they need.