How Your Ownership Structure Impacts D&O Coverage
Part 3 of 8: What Your Insurance Broker Isn’t Telling You
The ownership structure of real estate companies can be confusing for insurance carriers when writing policies. With the rise of Limited Liability Companies (LLC’s), many companies believe their owners are covered under a standard Directors & Officers (D&O) policy. But that’s not always the case. Here are three questions and answers to help explain:
1. What do D&O insurance policies cover?
A typical D&O insurance policy should cover:
- Lawsuits: D&O should cover the executive team (e.g. directors, officers, managing partners…etc.) for lawsuits by third parties.
- Other typical claims: D&O should also cover other claims including an allegation of misrepresentation and breach of fiduciary duty.
The most common misconception about D&O is that if you’re a private company then you’re not subject to shareholder suits, and thus do not need coverage. But this coverage applies to claims from competitors, suppliers, investors and lenders. Real estate companies have to interact with each one of these groups making this coverage necessary.
2. Why’s the coverage not as clear cut for real estate companies?
Over the last decade, LLC’s have become one of the most preferred forms of business entities through which to hold investment real estate properties. However, LLC’s do not qualify for coverage under a standard D&O policy. The reason being is ownership of the LLC is never by the First Named Insured (i.e. Parent Company), so it doesn’t make the standard definition of “subsidiary.”
Said another way – most real estate companies think they’re covered as their broker will make the statement “over 50% ownership will trigger coverage under subsidiaries.” However, they fail to point out “ownership” is triggered by the First Named Insured, not formed entities or individuals. Here’s a picture to help explain:
This is a problem because, in large D&O claims, the plaintiff will often name every entity remotely involved in the transaction including the holding company, management company, LLC, member LLC’s and the partners individually. The LLC will not be defended under the standard policy. Real estate companies do form LLC’s to limit personal liability, however, this will not stop the LLC from being named in a suit. Frequently, the D&O pays for the legal expense and the suit is resolved for non-monetary terms.
3. How would a D&O policy work for LLCs?
The following is an actual claims scenario where the coverage was structured to respond and defend the LLC.
Case: Two minority investors filed suit against the managing partners, holding company and asset LLC after a less-than-stellar year. The plaintiffs claimed the asset LLC breached its duty to the investors by mismanaging the asset, which resulted in a loss, despite previous forecasts of a significant profit. The plaintiffs further alleged that the asset LLC misrepresented the state of the market, which influenced their decision to invest.
Result: The carrier paid $300,000 in defense expenses before ultimately settling the case for $500,000. The D&O insurance carrier would have denied defense for the asset LLC as the
Does your broker understand the real estate industry and your ownership structure? Is he/she working with the insurance carrier to ensure proper coverage? If you need help or have questions, contact a member of the ‘A’ Team.
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- Real Estate Construction Types- What It Means for Underwriting
- 2017 Industry Outlook Video: Real Estate
- Real Estate Flyer
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