How do I avoid liability in my micro-enterprise or small business?

Business owners worry about liability.  They worry about being expected to pay money because of something their business—or an agent or employee of the business—has done or not done.  They worry about having their money or property taken or encumbered to satisfy a monetary obligation.  Liability can come from purposeful non-compliance with laws, like tax evasion.  It can come from failure to meet an obligation you’ve agreed to—like failing to make payments on a loan.  It can arise from negligence, meaning not being as careful as a reasonable person should be.  It can arise from recklessness—a willful disregard for the likely consequences of an action.  Liability can arise “by operation of law”—sometimes, the law says you’re liable whether or not you did anything wrong.  Liability can be direct—you did something that caused the liability. Or liability can be vicarious—someone else did something to create the liability, but you’re responsible for it.  Mistaken or stolen identity can give rise to liability too.  

As a short answer to how to avoid liability, I like to point to three basic concepts:  Be careful. Take advantage of limited liability entities. And insure around risk. 

Be careful. 

Too often we go through our days on auto pilot.  We’re really not considering what is going on around us.  On the other hand, if we consciously thought about liability with every little thing we did, we couldn’t live our lives.  Like chewing gum and riding a bicycle, avoiding liability and conducting business required balance.  We should generally structure our activities so that liability is avoided.  Sometimes, though, we should really give it some thought. 

Part of being careful is basic common sense.  But a few steps beyond common sense can be very helpful in building and maintaining the value of your business.  So, how can we “be careful” in our business practices?

• Understand your legal obligations.  In general, be aware of the law.  Understand laws that are specific to your business.  Review relevant online material related to your business and published by the regulatory agencies that are relevant to your business.

• Require compliance.  Being aware of the law is not enough.  You must strive to comply with the relevant laws and regulations. You must require your employees and subcontractors to comply with relevant laws and regulations.  It cannot be window dressing.  It must be an important your business model to do things in accordance with laws and regulations.

• Adopt and implement sound policies and procedures.  Having clear, written policies and procedures can significantly reduce the risk of legal liability. These documents should outline the expected standards of conduct, procedures, and the steps to be taken various circumstances.  Start with simple policies (For example: At XYZ, LLC, we drive in accordance with traffic laws.  We do not speed.  We obey all parking laws.  A moving citation or parking violation may be reason for adverse employment action up to and including termination.)  Your policies and procedures can grow with your company.  Ensuring that all employees are aware of and understand company policies is critical from a legal perspective.  It is also critical as a basis for developing a safety culture within your business.

• Seek professional advice and assistance.  Too often, people interpret “professional advice” in the context of liability as meaning “talk to a lawyer.”  While talking to a lawyer is important, there are many other professional advisers who can offer advice and assistance that will avoid liability.  At the top of this list insurance broker or agent.  Many insurance companies will have model policies and procedures that you can use free of charge.  They are not always perfect and sometimes require modification.  But your insurer is willing to provide them because what reduces risk for you reduces risk for your insurer.  Insurers can often provide model policies covering everything from driving or warehouse safety to data privacy or employment practices.  Your CPA, IT provider, and others may have model policies that will help reduce risk in your business.  Ask them.  The worst they can say is no.  And, the same agencies that will come after you if you don’t follow the laws often have model policies available too.  And, yes, talking to a lawyer is advisable too!

• Use written contracts to limit liability.  Written contracts can limit liability in many instances, but not all.  It is worth considering whether your business could benefit from the use of a written contract.  Talk to a lawyer to see if you can use a written contract to protect your business.

Insure around risk.

No matter how careful you are, mistakes can happen.  So, have insurance.  In certain cases, you may be required by law to have insurance.  I recommend talking to an insurance broker at length about your business insurance.  Sometimes, insurance really is expensive.  For example, if you own a trucking company that handles hazardous materials, insurance is going to be a big line item in your budget.  At some level—basic liability for example—if the business model cannot sustain the cost of insurance, it is not a viable model.  What insurance is necessary is a balancing question.  While you might curse every time you write a premium check, if you’re in business long enough, the day will come when you are or would have been saved by insurance coverage.  And, if you don’t have it, you’ll regret it.

What coverages you obtain will depend upon the nature and size of your business.  Common coverages to consider include the following:

• General Liability Insurance.  General liability insurance provides coverage for claims involving bodily injuries, property damage, and personal and advertising injury.

• Property Insurance.  Property insurance is vital to safeguard your business’s physical assets. This policy covers damage to your business property due to events like fire, theft, vandalism, and natural disasters. It includes coverage for buildings, equipment, furniture, and inventory.

• Workers’ Compensation Insurance.  Workers’ compensation insurance is mandatory in most states for businesses with employees. This insurance provides medical benefits and wage replacement to employees who are injured or become ill due to job-related activities. Workers’ compensation not only protects your employees but also shields your business from lawsuits related to workplace injuries.

• Employment Practices Liability Insurance (EPLI).  EPLI covers your business against claims made by employees regarding discrimination, wrongful termination, harassment, and other employment-related issues. It covers legal defense costs and settlements or judgments, helping to protect your company’s finances and reputation.  Often, the insurers provide an attorney hotline for legal questions touching on employment liability.

• Business Interruption Insurance.  Business interruption insurance helps cover the loss of income and operating expenses if your business operations are disrupted due to a covered event, such as a natural disaster or fire.

• Cyber Liability (Data Breach) Insurance. This insurance provides coverage for data breaches and other cyber incidents that could compromise sensitive information. Cyber liability insurance can cover costs related to data recovery, legal fees, notification to affected parties, and even public relations efforts to mitigate damage to your business’s reputation. Notably, this is a highly regulated area and even compliance with the notice requirements following a data breach can bankrupt a business.

• Professional Liability Insurance (Errors and Omissions).  Professional liability insurance, also known as errors and omissions (E&O) insurance, is essential for businesses that provide professional services or advice. This insurance protects your business from claims of negligence, errors, or omissions in the services you provide.

• Umbrella Liability Coverage for Owners.  Umbrella liability coverage may extend coverage for insurance coverage you have and cover gaps in coverage too.  It is generally very affordable and offers one more layer of protection for a business owner who has worked hard to accumulate a nest egg that they don’t want to lose due to liability from their business that threatens their personal assets.

Use of a limited liability entity.

A limited liability entity (LLE) is a type of business structure that offers its owners protection from personal liability for the debts and obligations of the business. This means that the personal assets of the owners, such as their homes and savings, are generally protected from claims against the business. LLEs do not protect the business itself from liability.  They only provide protection to the owners and the owners’ assets.  That said, LLEs are the key in protecting business liabilities from attaching to personal assets.  If you do business as a sole proprietor or in a general partnership, there is no liability protection.  If the business is liable, you’re going to personally liable too and your personal assets will be on the line to satisfy the liability.  If you do business as an LLC or corporation (or other form of limited liability entity), and your business is run correctly and properly capitalized or insured, business liabilities will remain business liabilities and will not attach to personal assets.  In this sense, LLEs do not avoid liability as compartmentalize it.  That said, they are an important tool for minimizing liability exposure.

In summary.

You can minimize your exposure to liability by (1) being careful, (2) insuring risk, and (3) doing business as an LLE.  You cannot eliminate risk.  But you can prepare for bad circumstances and prevent liability from bankrupting the business you’ve worked hard to build and from plundering the nest egg you’ve accumulated for you and your family.  In order to limit liability, you must act now.  If the bad circumstance has already occurred, it is too late—except to learn and do it better in the future.  Not avoiding and minimizing risk through these simple means is in and of itself too much of a risk to take on.