Serving on one's condo or association board is sometimes a rough job; there are tough decisions to make that impact the lives of one's own friends and neighbors, priorities to set that cannot possibly please everyone, and financial challenges that can make running even a small community feel like a game of roulette.

Given all of those pressures, the last thing condo, co-op, and HOA administrators need to worry about is getting sued over the decisions they make in the course of doing their job. Fortunately, protection from such damages exists in the form of Directors and Officers (D&O) insurance which, in a nutshell, protects board members from legal damages resulting from their decisions, as long as those decisions are made in good faith.

The D&O concept is fairly straightforward, but there are nuances to how the insurance product works which most condo owners, associations and management teams frequently don’t completely understand. Educating yourself and your fellow board members about D&O is vital however, and can save hundreds of thousands of dollars in damages.

Not a Simple Issue

According to Attorney Mark Pearlstein, a partner with the law firm of Levenfeld Pearlstein, LLC, with offices in Chicago and Northbrook, D&O insurance protects directors and officers who might be subject to claims and liability for decisions they make when managing a company or organization. The protection offered is insurance to cover the cost of defending a lawsuit against directors and officers, and in most cases, any damages awarded against these parties or the amount of any settlements of the claims.

In the context of homeowners associations, D&O insurance offers that protection for the directors and officers of the association or cooperative, shielding them against claims made against them in their official capacity as board members, or arising from contracts made by them on behalf of their associations.

Like all insurance policies, the coverage can get a little complicated. “It’s very broad,” says Steve Shappell, Esq., managing director of legal and claims of Aon Risk Solutions’ Financial Services Group in Chicago. “It’s an all-risk policy.”

Within that all-risk policy, Shappell says, there are different degrees of coverage: D&O may cover the directors and officers when they aren’t indemnified by the corporation (or association), but it may also provide coverage to the association to the extent it does indemnify directors and officers when there’s a claim. There are also two different types of D&O insurance: One that covers everything, or one that only covers the individuals when they aren’t indemnified, Shappell says.

It sounds complicated—and probably expensive—but the truth is that nearly all directors and officers in every condo or HOA should have it, Shappell says. “I would guess that 95 percent of companies would have a really hard time getting directors and officers to serve for them if they didn’t get insurance,” he says.

That’s because claims against directors and officers have been steadily increasing. According to a 2010 liability survey report by global consulting firm Towers Watson, 31 percent of all organizations can expect at least one claim made against their directors and officers each year. The bigger the organization, the more shareholders/residents, the more likely it is that a lawsuit will be brought against its decision-makers.

Condo and co-op communities are hardly immune—the report finds that those with less than $100 million in assets (which is pretty much every condo association in existence) still had a 12 percent susceptibility to claims.

Covering Your Assets

While legal entanglements usually spell headaches for boards, the law can also be used to help directors and officers. Section 12 of the Illinois Condominium Property Act (ICPA) requires directors of all condominium associations to carry D&O insurance.

As for co-op boards, “There is no statutory requirement for this coverage by directors of cooperatives,” Pearlstein says, “but it is prudent for cooperative directors to carry this insurance, and cooperative bylaws generally require the corporation to purchase the coverage.”

D&O claims cover a variety of actions taken by directors. In recent years, fair housing claims against board members have been a recurring theme, Pearlstein says. Challenges to increased assessments and building projects are also frequent grounds for lawsuits against boards and individual board members.

The cost of D&O coverage varies, depending on the underwriter and the size of the association in question, so like any service it's best to shop around and compare packages before signing on with a new carrier.

When negotiating the terms of your D&O coverage, there are a few things you can do to reduce your costs involved, says Pearlstein. “The first thing you can do is to reduce the number of claims against your board. The best loss prevention method for directors is to maximize their communications with unit owners, and always explain the reasons behind board decisions.” This cuts down on feelings of disenfranchisement among residents and allegations of secrecy or malfeasance against the board.

And while there are some minimums for D&O insurance, you can get as close to those minimums as possible by adjusting the way you present your risk to the insurers.

“Show that you have good, professional management and professional guidance,” Shappell says. “The more you can show that your risk of taking a misstep is at a minimum makes a difference.”

One other item worth mentioning in conjunction with D&O coverage is what's called fidelity bond insurance. Like D&O, it covers the association and board in the event that a building or HOA employee acts illegally and incurs legal damage. The bond be obtained by the co-op or condo as part of its insurance package, and ensures that any losses incurred by the bonded individuals are covered by the bonding company.

“In Illinois, associations with six or more dwelling units must obtain a fidelity bond for its employees including the property manager,” says Nancy J. Ayers, CPCU, CIC, senior managing director of insurance services at Mesirow Financial in downtown Chicago. Ayers says the buildings need to purchase a limit that will cover their maximum amount of exposure to cover funds in the custody and control of the association.

The cost of the fidelity bond is depended on the limit purchased and the number of employees covered. Some property and liability policies may include a small limit of fidelity coverage as part of their policy. A few of the insurance carriers also offer multiple coverages within their financial services policies, Ayers says.

Directors and officers and fidelity coverage may be sold as separate policies or combined under one policy with separate coverage parts. According to the pros, the majority of buildings opt to get D&O coverage and fidelity bonds as separate policies. The reason for this is that if you get them as part of a larger policy, you risk what's called 'erosion' in insurance jargon. For example, if you buy a $100 million total insurance policy with general coverage and D&O drawing from the same benefits pot, and your building finds itself filing a huge claim in the wake of a hurricane, that claim will likely eat up the entire allotment, leaving nothing to cover any subsequent claims made against how the board handled the storm repairs.

“That’s the reason why there’s a general tendency not to combine the D&O with other insurance—you always risk erosion,” Shappell says.

The Big But

The one absolutely vital thing for boards to be mindful of is that D&O coverage does not protect the board at large or individual board members from their own acts of bad faith, willful misconduct or any other action not authorized by the association documents. In other words, the legal costs of an honest, well-meaning mistake may be covered; if you incur damages as a result of shady practices or fraud, you're on your own.

Sometimes, it’s difficult to determine or prove whether a board’s bad decision was made in good faith or bad faith, however. “The key test is whether the challenged action falls within the stated powers of the directors under the governing documents or state law,” Pearlstein says. “If there is evidence that the board deliberately ignored the document or the law, that fact is prime evidence of bad faith. A prime example is an action by the board to spend association money without a vote at an open board meeting. Other than an emergency expense, directors cannot make spending decisions in secret.”

When a claim is brought against a board member, the board's D&O coverage will pay legal expenses as the association incurs these costs during litigation, and the carrier must then authorize any settlement of litigation against directors.

“It all comes down to the fact that when someone sits as a director, they will have certain promises made to them,” says Shappell. “If you’re accused of certain behaviors, and a claim is made against you, it’s expected that the board will have to promise to pay for your legal expenses, unless it’s found that you engaged in criminal activities.”

When D&O coverage is authorized, it will pay until the policy limit is exhausted. So if you have $10 million of insurance, the insurance will pay for the first $10 million of loss incurred. If you have $20 million in coverage, you get $20 million-worth of protection, and so on.

The real problem comes if your building has no D&O coverage when it needs it.

Without a D&O policy, the association or the cooperative may pay legal costs or damages directly from the funds of the corporation if necessary—and individual board members may pay directly from their own pockets. With judgments and settlements easily climbing into the millions, the impact of sub-par coverage can be devastating.

While nobody likes to think about the possibility of being sued, at the end of the day, a board's D&O coverage should be treated just like any other insurance product. It's a necessary layer of protection that enables board members to make the best decisions they can on behalf of their community without fear that actions taken in good faith could lead to ruinous legal consequences.

Danielle Braff is a freelance writer living in Chicago and a frequent contributor to The Chicagoland Cooperator and other publications.