Cannabis businesses run a higher risk of facing a “D&O claim,” or a lawsuit aimed directly at the directors and officers of the company rather than at the company itself.
While directors and officers of cannabis-touching companies may no longer have to worry about losing their freedom for choosing to work in the industry, they still have to worry about losing their personal assets through civil litigation. That’s right—their personal assets!
Cannabis businesses run a higher risk of facing a “D&O claim” or a lawsuit aimed directly at the directors and officers of the company rather than at the company itself. In some cases, fighting a D&O claim is so expensive it can bankrupt both a company and its owners. D&O claims in all industries have been steadily increasing for the last two decades and unsurprisingly, more and more of these claims are now popping up in cannabis. It is essential for any business taking the risks of working in the industry to plan ahead and protect themselves from this sort of expensive and damaging litigation.
Fortunately, cannabis businesses have the ability to safeguard their business with specialized D&O insurance coverage. D&O insurance coverage provides broad balance sheet protection for the organization in addition to asset protection for the directors and officers who may be held personally liable for their actions. Lawsuits can be filed by a variety of stakeholders, which is why potential claims can arise from various scenarios. Some common D&O risk scenarios include:
● Shareholder actions or derivative claims
● Reporting errors
● Misrepresentation of prospectus
● Failure to comply with regulations or laws
● Creditor claims
● Competitor claims
Why D&O Coverage is Essential for Cannabis Companies
Any business has the potential to be sued by its employees, competitors, or shareholders. In the cannabis industry it is even more perilous for directors and officers who must also navigate constantly evolving regulations and limited banking resources.
Due to federal law, state-legal companies operate in a grey area, making it difficult to access capital, use banking services, obtain adequate insurance coverage, and access other services that make traditional businesses competitive. Most insurance carriers will exclude claims that fall within federal jurisdiction, so it is important for any cannabis business to seek out coverage that is catered to the industry by people who understand and support it.
While D&O claim insurance is still rare in this emerging sector, it is available—and essential—for cannabis companies. D&O liability insurance protects the personal assets of directors, officers, and their spouses if a suit is ever filed. Most policies cover defense costs, legal fees, and settlements.
Traditional business financing is not available in the cannabis industry, which forces businesses to seek out capital from outside investors, private equity sources and/or venture capital. If an investor feels they were misguided, deceived, or wronged, they may decide to file suit directly against the company’s directors and officers. Any time a business takes on a new investor, they increase the pool of people who could file a D&O claim against them.
All of these factors contribute to a vulnerable industry with steadily increasing D&O class action lawsuits. Here are just a few of the industry’s most notable cases so far:
● Canadian LP CannTrust’s CEO Peter Aceto violated regulations by growing cannabis in unlicensed rooms. His actions led to an 85% decline in the stock’s price, a class action lawsuit, and a personal loss of $8 million in the form of stock options.
● Canadian LP Aphria’s executives were accused of overvaluing Latin American assets. The stock lost over 60% of its value, the company’s co-founders and CEO resigned, and a class action lawsuit was launched.
● American cannabis company MedMen’s executives are facing a $20 million lawsuit over accusations that include a lack of transparency as well as the directors and officers enriching themselves at the expense of shareholders.
● Cronos Group shareholders filed a securities class action lawsuit against the company as well as CEO Michael Gorenstein. The complaint alleges that Cronos’s statements regarding the size of its distribution agreements were intentionally omitted due to their relatively small size in comparison to the premium investors were paying for the stock.
Cannabis Exclusions and Why They Matter
It is necessary to work with an insurance brokerage that specializes in cannabis to reduce risks. Most cannabis companies still operate as startups, and exclusionary clauses put their personal assets at risk. Many policies contain specific cannabis exclusions, so businesses need to seek out policies that cater to the industry. Cannabis insurance brokerages are trained to spot exclusions in policies which leave directors and officers personally liable for damages.
Insurance companies that provide D&O claim coverage to cannabis companies often exclude certain types of claims in the cannabis industry:
● Bankruptcy exclusions
● Creditor exclusions
● Major shareholder exclusions
● Class action exclusion
● Prior acts
● Fines and penalties.
D&O Coverage as a Recruiting Tool: A Must-have for Cannabis Executives
A cannabis company with specialized D&O coverage has a significant competitive advantage in the hiring process. Many experienced executives coming to cannabis from other industries have become accustomed to working with companies that ensure their personal assets are safe from litigation. Whether a company is recruiting a new CEO, president, risk manager, or CFO, the first question these individuals will ask is simple: Does your company have D&O coverage?
If the answer to this question is no, then it is likely the company has already lost the recruit. When looking for a new landing spot, no corporate executive is going to risk joining a team where they can be held personally liable for their decisions.
When a company purchases D&O insurance, they can reassure potential hires their personal assets are not at stake. The insurance policy will often provide protection against some of these common claims:
● Disputes regarding human resources and employment law
● Failure to implement a plan that follows cannabis regulations
● Fraudulent misrepresentation in corporate dealings
● Negligence while performing duties
As a company continues to grow, D&O coverage becomes increasingly more important. This is especially true for companies working towards a public listing or in the process of sourcing additional funding.
Kirk Miller is a commercial insurance, risk management, and business strategy leader with more than 20 years of cannabis consulting and insurance industry experience. Kirk is an Executive Producer at Nine Point Strategies. Follow him on LinkedIn, here.