Cannabis business insuranceA client asked me earlier this week whether I thought his company should purchase insurance for their directors and officers. His accountant had advised them to do so, and he was looking for a second opinion. This issue has come up often over the years, so here’s a quick primer on D&O insurance and whether it makes sense for marijuana businesses.

At its core, D&O insurance is a way to protect a business’s directors and officers from being on the hook personally for their actions in their roles as directors and officers. Sometimes those suits can come from third parties, like creditors if the company is insolvent, or competitors for tortious interference with contracts, or customers for deceptive business practices. A large chunk of claims also can come from that same business’s shareholders.

Directors and officers owe multiple duties to their own companies. The big two are the duty of care and the duty of loyalty. The duty of loyalty mandates that the director or officer act in good faith in the best interests of the company, rather than for their own personal gain. The duty of care requires officers and directors act with reasonable care in exercising their company duties. You can violate the duty of loyalty by funneling company money toward your family members and you can violate the duty of care by making business decisions no reasonable person would make. Over the years, courts have tended to read the duty of care as an extremely limited duty — as long as there is a conceivable way to argue for what you did having been a business decision, it likely won’t violate the duty of care. If a director or officer violates one of these duties, one or more shareholders can sue those directors on behalf of the company, referred to as a “derivative suit.”

Company officers and directors don’t generally go into their jobs planning to violate their fiduciary duties to their companies, but they also don’t like the idea of being sued by shareholders for their management decisions. So companies make sure to sweeten the pot by offering protections against shareholder actions. One of them is indemnification, where the company agrees to indemnify an officer or director when sued in their role as officer or director. But indemnification is often limited by state law, where companies are not allowed to fully indemnify their officers and directors, especially for duty of loyalty violations.

The next layer of protection is D&O insurance. In a standard D&O policy, the individual officers or directors are covered when the company does not indemnify them. If the company does indemnify them, the company is covered for those costs. Finally, the company can be covered for additional claims against it, including potential securities claims.

For cannabis companies, the decision of whether to get D&O insurance is really no different than it is for other companies, except the premiums and coverage limitations may be different. Cannabis business is still pretty young in the actuarial world, and determining the exposure of directors and officers who are running companies that openly violate federal law is an interesting task. Like a lot of other services in the marijuana space, insurance underwriters tend to quote higher than ordinary rates for D&O insurance because of that uncertainty. For small marijuana businesses still run by their founders, D&O insurance plays the role of providing some liability coverage, but it isn’t necessary to attract outside talent.

Other than cost, one additional reason some companies choose to avoid D&O coverage is perception. If a director or officer wants a company to provide her with D&O insurance, that director or officer is saying she doesn’t want any of her personal assets to be on the hook for her company decisions. But if you look at it from the shareholder perspective, they already have significant personal assets on the hook. Many people have their life savings tied up in cannabis businesses, and there’s no such thing as shareholder insurance for bad decisions by management.

The vast majority of large public companies have some type of D&O insurance, and it is rare for really small companies. For those companies in the great middle, D&O insurance can make sense as a way to retain directors and officers, especially if the company is engaged in activities that invite lawsuits against directors and officers in their individual capacities. On the other hand, it is an expense, and shareholders like to see it when their directors and officers also have some skin in the game.

  • Jesse Kelley

    Does the violations of federal law preclude a marijuana business from D&O coverage? I know you mentioned higher rates in your article, but I’ve encountered business owners who are unable to secure D&O.