3 Vital Ways to Guard Yourself Against Small Business Legal Trouble

Solid contracts are just the start for guarding your personal and business wealth against legal risk.

The estimated reading time for this post is 11 minutes

In a country where anyone can sue anyone else at any time for any reason, it’s complicated to protect your business from a lawsuit. In fact, according to a 2005 SBA study, between 36-53% of small businesses will find themselves in litigation during any year. But, that doesn’t mean you can’t make it harder for someone to sue your small company.

The first strategy that protects your business is creating strong contracts. Here are three more. Click To Tweet

The first strategy you’ll employ is 3 Key Business Contract Elements That Can Prevent Legal Disputes that you got qualified legal help to prepare. However, since it’s not always enough to have firm contracts, here are three other equally important ways to protect yourself or your business from or during litigation.

Obtain and Maintain Adequate Business Insurance Protection

Whether you work from home, at an office site with your employees or in the field as a contractor or sales professional, you should have business insurance in place to protect your business activities. One of the most significant benefits the proper insurance protection provides your small business is legal and financial protection in a covered lawsuit.

In simplest terms, that means the insurer fights the lawsuit on your behalf and throughout the suit covers all legal fees and costs up to the policy limit. That, of course, depends on the statutory language of your insurance contract which is why it’s important to buy coverage right and whether you’re at fault in the lawsuit. 

However, most small businesses don’t have adequate insurance protection to cover the activities they’re conducting in their business. Frequently, that includes employer small businesses.

But, not having the right insurance coverage could leave you unprotected if you have legal issues or experience a catastrophe that substantially damages your business or even prevents you from conducting business. Moreover, often, knowing they will have to attorneys to fight a big insurance company keeps many people from suing your business.

Some prospective clients require you to have business insurance before working with you. Click To Tweet

With multiple kinds of business insurance, it’s impossible to cover all types here. Many policies have unique features, requirements, and endorsements. That gives you much to consider when buying insurance for your business. 

For instance, in some business sectors, specific coverage is necessary to get contract work. One of those is industries is construction. But, some clients in other sectors also require you to have insurance to work with them.

In fact, many large companies won’t work with your small business if you don’t have certain levels of insurance protection for the enterprise. Often, they won’t tell you that’s why; they’ll move on to the small business that does have that coverage. 

Homeowner's or renter's policies may restrict activities in or not cover your home-based business. Click To Tweet

Also, for those who work at home, remember that your homeowners’ or renters’ insurance policy may not offer any or enough business coverage so don’t assume it will. It may even place limitations on the kind of business you can conduct from home, and you’ll want to know that so your insurer doesn’t cancel your policy or deny any claims.

Talk to your insurance agent so you’re sure you have the right riders or endorsements on your homeowner’s or renters’ to cover business activities and claims. The same applies to using your personal auto for business purposes. Make sure you’re adequately covered with the right insurance before doing so.

More importantly, when buying business insurance, it’s usually best to work directly with an insurance agent than to purchase business insurance online. Use internet research to learn what’s available and how to cut your premiums but talk to a live human agent in your locale, even if by phone.

They’re best equipped to help you set up the right levels of coverage within your budget and put that insurance in force. Once you get it, do all you can to keep this vital business protection.

You really can't afford to be without the right business insurance coverage. Click To Tweet

Finally, don’t assume that you can’t afford insurance. You can get and keep cost-effective protection now and as your business grows, add any more coverage needed. You really can’t afford to be without the right business coverage, especially if you’re in an industry where legal challenges are common like construction, law and consulting.

Make sure your insurance agent helps you get the right protection so if you get sued for a covered event, you have insurance coverage.

Consider Forming a Legal Entity

Legal entities, like LLCs, LLPs, LPs, S-corps, C-corps, B-corps and even trusts can offer personal and business asset protection in the form of limited liability that shields business owners from personal liability for business debts. The level of protection depends on which you choose.

These entities allow you to run legally under their protection and, often, give your business more credibility. Sometimes, the knowledge that you work under entity protection and are correctly doing so may stop small plaintiffs from pursuing you legally.

Operating under an entity can protect personal assets if your business faces a lawsuit. Click To Tweet

There are too many aspects to consider in choosing which entity is right for you and your business to cover here if you decide to go this route. But, here are a couple of considerations. 

Make sure the one or combination you choose protects your personal property, especially your home, financial and other personal assets if someone files a lawsuit against your business.

Operating properly under an entity can protect those personal assets from attachment by judgment creditors if your company faces a lawsuit. You don’t want to have to liquidate your personal assets to pay a legal judgment.

You’ll want to protect your business assets, too. So make sure you form an entity or combination of them that protect your business assets, also. Then, properly structure any entities you create for the most robust limited liability protection.  

Observe corporate formalities to prevent loss of entity limited liability protection. Click To Tweet

After formation, you must run your entity like it’s a real business, not an “alter-ego” of you and your business partners. It’s the only way to keep your “corporate veil” intact or the limited liability protection an entity provides.

You do that by observing corporate, company and legal formalities related to operating under entity protection in the jurisdiction where you formed your entity. After formation, you take all actions on behalf of the organization, usually as an officer.

You also keep adequate books and records in which you execute resolutions or related documents (which depend on the entity or jurisdiction) to formalize and document the actions of the entity and those its officers take on its behalf.

Have operating agreements, bylaws and similar documents in place. You also must conduct annual or any other required meetings that for your entity type in your jurisdiction.

Don't combine assets. Keep personal and business banking transactions completely separate. Click To Tweet

Also, don’t combine assets, meaning your business has a separate business bank account under its tax ID or EIN where you conduct all business but no personal financial transactions. You get all business credit in the name of the company and pay all business taxes on time.

Moreover, keep all state or local registrations up-to-date and pay your registered agent and annual report fees on time each year. Also, make sure you can legally operate your business in the jurisdiction where you run it by registering there, too, if you’ve formed your entity in another state.

Otherwise, if you get sued where you conduct daily operations, you could find yourself unable to fight the lawsuit in local court.

If you don’t form your entity correctly and run it correctly, you may find that a judge can pierce your corporate veil. That means they can lift that legal veil of limited liability protection and hold the entity’s owners, members, and shareholders personally liable for business debts.

That makes it possible for a creditor to go after your home, bank accounts, investments, and other assets to satisfy the company debt a judge has ruled you now owe personally. 

Accordingly, while many small business owners conduct online research and even form their entities online, that is not always advisable. For instance, if you have a complicated business situation or will have business partners, it’s a good idea to speak to the right type of local attorney for your business. Unlike most online self-service sites, in complex situations, a local attorney is best to help you form your entity or entities correctly.

Speak to qualified accountants and lawyers in your industry about setting up your entity properly. Click To Tweet

Also, talk to a qualified accountant, one who specializes in your type of enterprise, to help choose the proper tax status and tax year for your entity or entities before obtaining an EIN. You also should consider having them set up accounting and assist you with tax filings, especially if your business collects sales tax.

While this professional help requires an investment, it’s important to know when you can’t depend only on what you learn online and through books as a substitute for their support.

You’ll want to speak to both tax and legal professionals to make sure you can keep the full limited liability protection available under these entities. It’s best to do that early in the process and periodically to stay protected.

By setting up your entity correctly from the beginning and correctly operating it going forward, entities can give you more protection either from or in the case of a lawsuit.

Don’t Breach Contracts or Cause Clients Legal Problems

Many small business owners don’t recognize how important this is. There are few things worse than an independent contractor either nearly getting your business sued because they failed to perform their duties to your client under your contract with them or making such an egregious error that they cost your business significant contracts.

Don’t be that small business owner. Operate your business with the all due care required by the law and conduct activities deliberately and professionally.

Performing poorly as a contractor can lead to lawsuits against you or your business. Click To Tweet

Otherwise, you could find yourself and either getting no pay or, worse, your client suing you because against you allegedly committed a wrongful, fraudulent or careless act against their business. A lawsuit could be devastating to your business because most legal suits are public record and the details of your contract breach would be available for future clients to find. 

You’d be fortunate if all you lose is a relative few dollars by their refusing to pay you because you breached the contract and cost them business or damaged their reputation. 

If you pursued litigation for nonpayment in that situation, once that defendant stated what you did, you’d likely lose the suit. Moreover, your business or personal reputation could be permanently damaged because most business lawsuits are public record for anyone to see.

Circumvent legal problems with clients by doing your best work and resolving issues promptly. Click To Tweet

Instead, avoid this situation by doing your best work at all times, letting your client know if issues are preventing you from doing so. Refuse to do projects that you know you can’t or shouldn’t do until the customer addresses and resolves those issues.

Reject work you’re not professionally qualified to perform and don’t let the client push you into doing work you know is outside your ability. Let them find qualified help in that area and stick to what you know how to do. Otherwise, expect to be held responsible for your poor performance, which may cost you money.

Also, make yourself available and simple to contact throughout the project, so your clients aren’t left hanging and fearing you’ve absconded with their money or abandoned the project. There’s little more stressful than trying to explain to a customer that a subcontractor working on their project is missing in action. Whom do you think they blame for that?

Be a Smart Business Owner: Protect Yourself

Being in business is challenging enough without feeling or being unprotected from unexpected litigation taken against your company. It can feel very personal, but it doesn’t have to have personally damaging consequences.

Avoid being one of 90% of American businesses in lawsuits at any given time. Click To Tweet

Don’t just take the information here and apply it to your business. Work with your legal and financial professions to consider these and other steps to protect your business from litigation.

That way, you can avoid being one of the 90% of American companies who find themselves involved in some form of litigation in any period. If you do find yourself fighting a court battle for your business, you may have put in place the shields that can mitigate damage.

This blog post is not meant to be or replace legal, accounting or financial advice. Please carefully review this site’s Content Disclaimer to learn how to apply this information correctly, if at all, for your business.

(c) 2015-2018. Dahna M. Chandler for Thrive Writing, Inc., a division of Thrive Media, Inc. All rights reserved. This article may not be reproduced in whole or in part without express written permission of the author.

Image Credit: Pixabay.com

I’m an award-winning finance journalist with marketing expertise and business acumen. I offer engagement-generating, personal finance and small business development content writing services to thriving—high growth or established—blogs and media outlets. My passion is to help your consumer readers make their dollars make sense and operate their business with growing wealth as their focus.

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