Every business should have a comprehensive, up-to-date executive protection plan. Most do not. The executive protections at most businesses are non-existent, disjointed, out-of-date, or some combination of all three.
This month’s newsletter is the first in a series that will examine the several elements of an executive protection plan and discuss how these elements interrelate. This month’s newsletter introduces the topic of executive protection. Subsequent newsletters will address the substantive elements of an executive protection plan. This series will focus on the predominant forms of business entities in use today: corporations and limited liability companies (LLCs). We will address the special issues of nonprofit organizations and sole proprietorships in separate publications.
Executive Protection Is Emerging as a Critical Corporate Governance Issue
We use the term “executive protection plan” to refer to the mechanisms available to mitigate the personal liability of the members of a business’s governing body and the business’s officers (collectively, “Executives”). The risk-mitigation mechanisms are: (i) an exculpatory provision in the business’s governing documents that limits the Executive’s liability to the business or the business’s owners for certain actions; (ii) a right to indemnification from legal action; (iii) a right to advancement of defense costs; (iv) directors and officers liability insurance; (v) risk management through the business’s operations and structure; and (vi) personal planning by the Executives.
Although these risk-mitigation mechanisms are not new, the concept of a comprehensive executive protection plan is emerging as a focus in corporate governance. In today’s increasingly regulated and complex global business environment, Executives face heightened risk of personal liability for business decisions. This is true for businesses of all sizes, from family firms to publicly traded companies.
Two trends in particular have pushed executive protection to the forefront of the corporate governance agenda. First, as a result of the credit crisis, the “great recession,” and the rise of cyber threats, regulators and shareholders have shown increasing willingness to pursue personal liability claims against Executives. Second, in response to these pressures, many companies have increased their self-policing through internal compliance programs and internal investigations. Internal investigations, in particular, can expose an Executive to substantial risk even when the investigation concludes that the Executive engaged in no wrongdoing.
As a result of these trends, businesses and Executives are revisiting executive protection as an issue requiring comprehensive planning. For a business, a poorly constructed executive protection plan may hamper recruitment and retention of talented Executives. For an Executive, a poorly constructed executive protection plan may have unintended gaps in coverage or may offer protection that is not adequately scaled to the magnitude of the risk.
The challenge of executive protection planning is to balance the risk to the Executives against the risk to the business arising from Executive misconduct. No single rule or best practice dictates the appropriate scope of an executive protection plan and the law imposes few limitations. The governing body, Executives, and owners of each business must determine the correct balance of risk based on the business’ unique circumstances, such as risk profile, industry custom, and shareholder and Executive risk tolerance.
The attorneys in our Business practice group advise clients regularly on executive protection and related business governance issues. We are attuned to the latest issues and trends in business governance and participate in the nationwide development of best practices.
For more information please contact a member of our Business group or call 208.344.6000.