Entrepreneurship M4 SLP for Paula Hog

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Who Might Sue or Be Sued ....................................................................................................................... 122

Co-Owners ............................................................................................................................................123

Landlords, Customers, and Other Parties to Business Contracts ...........................123

Employees.............................................................................................................................................. 124

Outsiders................................................................................................................................................ 127

Risk Management Strategies ................................................................................................................... 127

Find Out What Can Go Wrong ..................................................................................................128

Focus on Prevention ........................................................................................................................129

Deal With Problems ......................................................................................................................... 131

Insurance and Warranties ......................................................................................................................... 132

Property Insurance ...........................................................................................................................133

Liability Insurance .............................................................................................................................134

Specialized Insurance....................................................................................................................... 135

Investigating and Purchasing a Policy .....................................................................................136

Manufacturer’s and Extended Warranties ........................................................................... 137

C H A P T E R

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122 | THE SMALL BUSINESS START-UP KIT

C hapter 1 explained the different business structures that exist and how they relate to liability issues. As discussed, creating a corporation or an LLC generally protects business owners from personal liability. If the corporation or LLC loses a lawsuit or otherwise finds itself in debt, only the business will be liable for the debt, not the owners. But in a partnership, each partner is 100% personally liable for all the business’s debts and obligations. True, these debts should normally be shared among the partners, and one partner can sue the others to force them to pay up. But this not a very satisfying option if the other partners are broke or have disappeared.

Shielding owners (or employees, as discussed below) from personal liability is a totally different issue from shielding the business itself. In fact, when an individual owner or employee avoids personal liability, you can usually assume that the business will be stuck with it. The owners and employees might be happy they are not personally liable, but there’s not much to cheer about when the business assets are wiped out to satisfy a judgment.

The bottom line is that a successful lawsuit against a business can be devastating, whether or not the owners are personally liable for the damages. No matter who ultimately faces liability, every business should consider where risks lurk and how to avoid them. In our litigious society, you must take liability issues seriously and take active steps to protect your business and yourself.

Though the world of possible lawsuits is limited only by lawyers’ imaginations, most claims arise from predictable—and often preventable—situations. If you analyze the true risks that face your business and employees, you can learn to recognize where your business is truly vulnerable and reduce the likelihood of ending up in court.

This chapter outlines the typical risks your business might face, and offers guidance on how to reduce them. It also discusses who and what may be at risk—including the owners, the staff, and the business itself. Then it offers risk management strategies and techniques to reduce your exposure to liability.

The encouraging news is that there are things you can do to protect yourself and your business. Hiring carefully, training thoroughly, having solid personnel policies in place, maintaining a safe working environ- ment, and purchasing insurance are important risk management techniques that all businesses should use. It’s crucial to do as much as you can before any legal issues arise.

SEE AN EXPERT

Get advice on possible liability claims. Liability issues typically involve gray areas, so the only way

to determine absolutely whether someone will be held

responsible for a particular act is to find out in court—an

expensive way to get an answer. Use the information in this

chapter as a foundation for understanding what can go

wrong, and do your best to reduce your risks, but consult

an attorney if you fear possible legal trouble. And run, don’t

walk, to an attorney if you receive an official document such

as a court order, a subpoena, or a written complaint that

signals the start of a lawsuit. (See Chapter 16 for advice on

finding and working with an attorney.)

Who Might Sue or Be Sued Pretty much anyone you deal with in your business can sue you or the business, and vice versa. What you want to do is ward off claims by understanding your risks and taking steps to avoid problems. This section lists what could possibly go wrong for a business, divided according to which people are involved. You can read it as a checklist now, or come back later to make sure you’ve covered the most likely risks for your business.

The most likely kind of claim or lawsuit that could be brought by or against your business will be over a contract or agreement of some sort. That’s because businesses routinely buy, rent, make, sell, or provide products or services—and all of those transactions involve contracts, whether written or oral. Most small businesses find their main problems are money related, whether it’s getting paid by

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reluctant customers or insurers or meeting their own financial obligations by paying their suppliers, landlord, or employees. Problems like these are called “contract” claims, because they stem from contractual agreements.

A less likely but extremely serious risk can also arise when someone in or around your business gets injured—financially or personally—by some act not related to a contract. For example, if one of your employees injures someone by being negligent, typically the business will be liable. A lot of your risk management efforts will be directed at preventing these kinds of claims—called “torts” in legalese—because they can be very costly to you and your business.

Co-Owners If you are a co-owner of your business, you and the other co-owners have many obligations to each other. That’s because mismanaging the business, whether on purpose or unintentionally, can damage the owners’ investment and may expose all owners to liability.

Claims between and among owners can arise from one owner:

• lying—for instance, about cash flow or customer complaints

• self-dealing—working for personal interests instead of the business’s

• stealing the business’s money or taking business assets for personal use

• handing out profits incorrectly • selling property for less than it’s worth • conspiring—for example, to defraud or push

out one of the co-owners • failing to live up to the business agreement—for

instance, by not contributing the amount of time and money agreed

• mishandling company funds • mistreating the employees • making bad deals • producing bad products or providing poor

service • defrauding lenders, customers, landlords, or

suppliers • failing to pay payroll and/or income taxes

• violating laws and regulations of various kinds: safety or securities regulations, local ordinances, employment laws, or antitrust laws

• failing to properly hire, train, and supervise employees, or

• failing to observe formalities, such as recording corporate minutes or keeping personal money separate from business money.

There are many possible claims involving those who venture into business together. For example, even if you’ve done nothing wrong personally, a partner could sue you for your share of partnership debts, which may result in an expensive verdict or settlement. If your co-owner is your spouse and you get divorced, the business could get mired in the tussle over marital assets. Or if you and your co-owners decide to stop being in business together, you could sue each other over mismanagement, unfair competition, wrongfully expelling a partner, or other irregularities in splitting up.

Landlords, Customers, and Other Parties to Business Contracts As mentioned above, business contracts are a common source of claims and problems. Lenders, suppliers, landlords, and customers could sue you—just as you could sue them—over contracts. For instance, your landlord could claim rent was in arrears or that you damaged the premises. Or you could sue your landlord for failing to make promised repairs or improvements. You could take over a lease or a contract and find that you are obligated for more than you agreed to take on. Customers could claim that your goods are shoddy and your return policy inadequate. Or you could have a supplier who gives you substandard goods.

Injuries outside of contractual agreements are the other main risk. Claims can be based on acts that were either intentionally bad or just unintentionally unfortunate. Customers could be accidentally injured on your premises or by your products. You or another partner could physically assault, harass, or make racially derogatory remarks about a supplier or customer. Your customers could claim that you Co

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124 | THE SMALL BUSINESS START-UP KIT

were not careful enough in hiring, training, and supervising the employees—who subsequently hurt someone or something. You could have a claim if a business contact assaults your employee or steals your property. The people who hire your former employee could claim you gave a falsely positive recommendation.

Employees Many businesses simply can’t operate without employees to help. These extra minds and bodies may be essential to the business, but they can also be the targets and sources of liabilities and lawsuits.

Owner’s Claims Against Employees

A business owner may sometimes be compelled to sue an employee. Theft and property damages are common impetuses—although it may not be cost- effective to take a pilfering employee to court for small reimbursements or money owed for small repairs.

In almost every case, someone who is injured by your employee will choose to sue you—not the employee. An injured person nearly always looks for a way to sue the employer, who usually has assets, including insurance. An employer who has to pay an injured person for harm caused by an employee could theoretically sue the employee for reimbursement, but it’s not worth the trouble if the employee has no money.

A rare but important problem is that employees sometimes steal customer lists or a secret process or invention, then go into business in competition with their former bosses. An employee with a head full of business information and years of experience in the field can be a formidable competitor, even without stealing trade secrets or a customer list.

RESOURCE

For more information on restricting business information. State laws vary considerably on how much and how long you can effectively restrict a former employee

or associate from going into competition with you. For

guidance, see the article on nondisclosure agreements in

the Free Legal Information section on Patent, Copyright

& Trademark on www.nolo.com, and the website www.

ndasforfree.com.

Risks Facing Employees

Employees may have to pay an injured person for damages for injuries they cause at work by:

• failing to act reasonably and carefully—for example, working without enough sleep when they need to stay alert

• acting with reckless disregard for the safety or interests of others—for example, removing safety equipment from a machine or ignoring warnings, or

• hurting someone deliberately or breaking the law.

If the person injured is a coworker, the legal relief is usually limited to workers’ compensation benefits.

Owner’s Responsibility for Claims Against Employees

A business owner’s responsibility for harm done by an employee is an area of potentially very serious liability. There are two different ways an employer may be held responsible for the harmful acts of an employee: when the employer is at fault in some way, and when the employer isn’t at fault at all. This is surprising, but unfortunately true.

In general, an employer is liable for everything an employee does “within the course and scope of employment,” because the employee acts as the employer’s agent. This means that for legal purposes, it is as if the employer directed an employee’s every move, simply by authorizing the employee to act. For instance, the U.S. Supreme Court held that a real estate corporation was “vicariously liable” for its salesman’s illegal discrimination when he refused to accept a biracial couple’s offer to buy a house. (Meyer v. Holley, 537 U.S. 280 (2003).) The ruling expressly held that the corporation’s sole owner was not personally liable. This effectively protected the

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corporation owner’s other assets by limiting liability to the corporation itself—exactly why some business owners choose to incorporate.

An employer obviously should be held responsible when the employer tells the employee to do something and the employer knows that act will probably cause harm. An employer who knows or should know that the employee is harming someone or something will also be held culpable.

In addition, an employer is often legally responsible for an employee’s acts—even when the employer did not direct the employee to do the act that caused the trouble and didn’t know that the employee was doing it—if the employer should have done something to prevent the situation from arising. For example, an employer may be liable for carelessness in hiring, training, or supervising an employee who causes some harm on the job. This can be true even when the harm happens after work hours or away from the work premises, as long as there is some connection to the job.

Liability for Independent Contractors

An independent contractor is someone who works for you but is not a regular employee. (For a discussion of the differences between an independent contractor and an employee, see Chapter 15.)

Employer liability for an independent contractor’s acts is a complex area. Because a typical independent contractor works offsite, using his or her own equipment, without direct supervision, a business owner usually has little control over how the work is done. Nonetheless, the employer may still be liable to anyone who is hurt by the finished product that the independent contractor produces—for instance, if the employer uses the product at the business site or sells it to the public.

Fortunately, independent contractors often have insurance, so an employer who is sued can in turn sue the independent contractor for mistakes. For more information, see Consultant & Independent Contractor Agreements, by Stephen Fishman, and The Employer’s Legal Handbook, by Fred S. Steingold (both published by Nolo).

Claims by Employees Against Owners

Employment-related claims may pose a major liability risk to businesses with employees. Lawsuits alleging wrongful termination, sexual harassment, or other types of illegal discrimination are a serious risk to all businesses—and possibly to individual owners, managers, and employees. Here’s an extremely brief and simplified outline of the types of workplace- related suits commonly faced by businesses.

Wrongful termination

In every state but Montana, every employee without a written employment contract has a job only as long as both the employer and the employee agree to continue the employment. An employee can quit at any time, for any reason or no reason, and the employer can fire the employee any time, for any or no reason. This is a legal doctrine called “employment at will.”

There are major qualifications to that general rule, however, that may open an employer to a lawsuit for firing a worker. For instance, an employer can’t fire someone for an illegal reason, such as wrongful discrimination (discussed below), in retaliation for union organizing, or whistleblowing—reporting the employer’s wrongdoing to a government agency. In these cases, the employees could sue their former employers for wrongful termination.

And employees who have written contracts setting out conditions of termination—an increasingly rare breed—can sue a business on a claim that the company did not have “good cause” to terminate the employment. This is a “breach of contract” claim. Most businesses avoid these claims by making it clear in writing that all their employees are at will.

Defamation

A business that gives out false and damaging infor- mation about a former employee may be sued for harming that individual’s reputation—also called defamation.

Defamation may rear its head for business owners and managers who are asked to give references for former employees. In most states, there is a legal defense called a “privilege” that protects people who

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give job references in good faith or when negative information is true. However, if sued for defaming a former employee, it would still cost time and money to prove that defense in court and win the case.

Another problem is that, while you may believe something to be true, it is always possible to argue about the truth of subjective evaluations and personal experiences. To combat this, some managers refuse to comment at all about any former employee, except to confirm that the employee worked for the business and when. Though this may be a wise policy for problem former employees, it also limits the opportunity to pass along good information about good workers. It’s best to use discretion.

Another time for business owners and managers to beware of the possibility of defaming a worker is during the firing process, when emotions often run high. It’s always wise to keep termination discussions brief—and tied to specifics about an individual’s work performance.

Sexual harassment

Sexual harassment is any unwelcome sexual conduct on the job that creates an intimidating, hostile, or offensive work environment—and by now you’re surely aware that it can expose a business to liability. Some courts categorize harassing behavior as either “quid pro quo” or “hostile environment.” In quid pro quo harassment—literally, “do this for that”—a worker is confronted with demands for sexual favors to keep a job or get a promotion. Hostile environment harassment is found when sexual jokes, pictures, innuendoes, or comments are allowed to persist in the workplace.

A business can help avoid these types of claims by putting a strong sexual harassment policy in place and strictly enforcing it—along with offering periodic training for all employees on how to recognize and report sexual harassment on the job.

Illegal discrimination

Federal law prohibits discrimination in employment based on race, skin color, gender, religious beliefs, national origin, disability, or age. And state and

local ordinances sometimes protect additional characteristics, such as marital status, obesity, or sexual orientation. That makes it illegal to use any of these factors in decisions about hiring, promoting, making job assignments, firing, or paying workers. It is even a bad idea to ask questions about those parts of an applicant’s background before the business gives the offer to hire. Savvy businesses use clear job descriptions, review standards, and termination guidelines to avoid claims of discrimination. And, of course, epithets or hostility on the job based on these protected characteristics should not be tolerated.

But discrimination law can get more complicated, making it necessary to pay attention to reality rather than blindly enforce workplace policies. An apparently neutral job requirement may disproportionately harm members of a protected group. For instance, in several states, black male employees have successfully challenged grooming codes requiring all workers to be clean-shaven, based on medical evidence that black men are disproportionately likely to suffer from a skin disorder giving them painful ingrown hairs after shaving.

A growing number of discrimination complaints these days are filed by employees who have disabilities. A federal law, the Americans with Disabilities Act, requires an employer to make “reasonable accom- modations” for an employee who has a disability but is otherwise able to do the job—as long as the employee requests an accommodation and the business can provide it without suffering hardship. The accommodation may be buying a special chair, computer, or other equipment, or installing a safety bar in the restroom. It may be allowing the employee to reduce work hours to undergo chemotherapy, or reassigning an employee to a job that requires less lifting or standing.

How far you must go to accommodate an employee varies depending on the facts of each situation. You need not always provide the most expensive accommodation or the exact one an employee requests. At a minimum, you and your employee should discuss and negotiate what accommodations are possible and reasonable.

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The Americans with Disabilities Act also requires many businesses and buildings to be made accessible to people with disabilities. Not complying with that law is another form of illegal discrimination.

Another growing area of discrimination claims arises from bringing religion into the workplace. Employees may complain that they are being harassed by evangelical coworkers of a different religion or upset by required prayers at business meetings. But if the business forbids all religious practice, employees may claim that they have a right to practice their religion at work, including praying and proselytizing. Employers often handle this by restricting religious and personal postings to a designated bulletin board and prayer groups to nonwork times. However, a business should generally accommodate employees’ religious practices, including religious garb and religious holidays.

Privacy

The flip side of bringing an employee’s personal beliefs into the workplace is that many employees do not want an employer to know about their lives outside the office. Be sure to check the laws in your state before you start monitoring employees’ off-duty pursuits, social media activity, or drug use. A manager who inquires about whether an employee went to church on Sunday may be both invading privacy and appearing to discriminate based on religious beliefs.

Recent years have seen a great deal of legislative activity regarding what employers may or may not do in terms of monitoring employees’ activity on social media. Federal laws prohibit employers from discriminating against an employee or applicant based on information they glean from social media related to the individual’s race, color, national origin, gender, age, disability, or immigration status. More specific laws regarding employers’ access to or use of social media information about employees or applicants exist at the state level. Several states have passed laws prohibiting employers from requiring passwords or login information from employees for their social media accounts.

Laws vary a great deal from state to state, so if you have any plans to track your employees’ or applicants’

social media activity and use that information in hiring or termination decisions, be sure to learn your state’s laws. One good source of updated information is the National Conference of State Legislatures website at www.ncsl.org.

In some states, a business may legitimately require a drug test prior to offering a job. The employer may also require drug testing on the job if there are specific and significant reasons why drug testing is necessary, such as when employees handle dangerous machinery or drive on the job. However, many potential legal hazards can be addressed simply by having a rule that forbids being “under the influence” of any substance at work. An employee can be held responsible for truly dangerous or inappropriate behavior without requiring an invasive or humiliating test. Keep in mind that some prescription and over- the-counter drugs also may temporarily affect an employee’s mood or concentration.

Personal injuries

An employee who is injured on the job cannot usually sue the employer or another employee for damages, because state workers’ compensation laws provide insurance benefits to cover those injuries. State or private disability insurance may also help compensate an injured employee, although only a handful of states have disability insurance programs.

Outsiders People you never expect to come into contact with your product or service could be injured by it. In some states, even trespassers who get injured on your property can sue you. And you or your employee might get into an auto accident in a company car, or on company business, and sue or be sued. You might also commit a crime that, as a side effect, harms someone.

Risk Management Strategies “Risk management” refers to actively addressing, managing, and reducing risks for any business. It is a rapidly growing field, partly because of the widespread and realistic fear of lawsuits. Your first

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goal is not to win a lawsuit, but to avoid a claim altogether. Your second goal is to resolve a claim without a lawsuit. Only as a last resort should you venture to court, because it’s usually very expensive, and the outcome is always a gamble.

Insurance is part of a risk management program, but beware that it does not in itself constitute risk management. Sometimes the protection of insurance is adequate, but in some cases insurance may be either too expensive or simply unavailable for particular activities. (See “Insurance and Warranties,” below, for more specifics on insurance.)

Here’s one example of risk management: Many commercial and industrial sites have residual contam- ination from solvents, metals, and chemicals. If you buy the property, you may legally have to pay for environmental cleanup, even though the mess wasn’t your fault. So, before you purchase, you should consider some ways to manage your risk.

Here are some possibilities: • You could evaluate the likelihood and extent of

contamination with scientific sampling by an engineering firm that also provides an estimate of the probable cost of cleanup. Then you would weigh whether the purchase is worth the additional costs.

• You could try to get protection through con- tracts—for instance, you could try to purchase insurance directly, or to negotiate a reimburse- ment agreement or an agreement to purchase environmental insurance from the seller.

• You could ask the relevant government agencies for a “comfort letter,” in which they promise— or at least come close to promising—that their lawyers will not go after innocent landowners. Your bank may require this letter as a condition of a loan.

• You could look into a federal “brownfields” program, which gives you certain immunities from future surprise liability if you clean up urban industrial land.

As you can see, many options are available to manage that one potentially expensive risk.

Find Out What Can Go Wrong A good place to start your risk management program is to outline what the business is trying to protect— for example your people, physical and financial assets, and reputation. Then you can move ahead to anticipating potential threats.

In addition to general risks, find out what can go wrong in your field. Talking with an insurance agent who is familiar with your type of business is one of the best ways to assess the possible risks you face. Talking with people who own or work in similar businesses is also useful, especially outside your local area; if they don’t compete with you, it’s more likely you can trust what they tell you. Reading trade magazines and websites will keep you abreast of the kinds of lawsuits being brought. And, finally, ask your employees what risks they see and what problems are waiting to happen. They may be one of your best sources for ideas to prevent problems.

Liability Lurks All Around You

There is a sea of laws and regulations controlling safety, land use, business, employment, and other matters that business owners must abide by—and ignorance of them is no excuse. You never know when you will be hauled up short for parking too many cars on the street, having an unsafe workplace, or causing an environmental disaster. You should have a pretty good idea, though, of the kinds of laws that apply to you, especially if you are in a heavily regulated industry such as manufacturing, food preparation, or professional services. There can be harsh penalties (including prison time) if, for example, you fail to report a workplace death to the appropriate agency.

Finally, it should be no surprise that you can also get in trouble by breaking various criminal laws. Businesses traditionally have special problems with failing to pay taxes; with property crimes such as theft, fraud, and arson; and with antitrust laws that prohibit forming monopolies.

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Focus on Prevention Once you’ve identified the main ways that your business is vulnerable, you should brainstorm ways to protect against these risks.

Setting a Solid Foundation

Most obviously, you should choose your partners, lenders, landlords, business sites, vendors, agents, and employees carefully. In particular, investigate in depth any deal that seems too good to be true—including the sales pitches of people who encourage you to set up in a franchise or buy expensive equipment.

Next, if you will be a joint owner of the business, get a clear understanding with your co-owners about all aspects of your business: what you want to accomplish, what you expect from one another, and how or when you might split up or buy out a co-owner. Agreements known as buy-sell agreements outline how the business will handle transfers of ownership. (Buy- sell agreements are discussed in Chapter 14.) Money is usually the first big issue; control is next. You would be wise to have your business formation agreement in writing, whether it’s a simple one-page partnership agreement or a detailed operating agreement for an LLC. If possible, co-owners should agree to mediate disputes. Mediation is generally quicker, simpler, and cheaper than a lawsuit, which is why the business community has adopted it enthusiastically.

It goes without saying that you should operate your business on the up-and-up. That includes:

• filing all the required papers and getting the right permits

• telling the truth on all documents and to everyone with whom you deal

• keeping track of company funds, inventory, and important documents

• paying your debts • delivering what you promise • observing business formalities, such as keeping

your personal money separate from business accounts

• putting important agreements into written contracts

• maintaining safety standards, and • complying with all applicable laws, especially by

paying your income and payroll taxes quarterly. Owners must make sure their businesses comply

with bureaucratic requirements. Applying for permits and licenses, filing reports, paying taxes, and so on are necessary evils for all businesses, and failing to do these things may, in some cases, expose the owners to personal liability. (Permits, licenses, and other bureaucratic hurdles are covered in detail in Chapter 6.) Even if a manager or another employee is in charge of filling out and filing the paperwork, ultimately it’s your responsibility as an owner to make sure your business is in compliance. Check in regularly to make sure that paperwork is getting done.

Risk management can affect your decisions about what your business actually does. You may need to change or eliminate certain activities that are uninsurable or too risky. What is too risky may depend on the law and the availability of insurance in your state—especially for construction, manufacturing, and professional services.

Implementing Procedures and Checklists

Particularly if you can identify one or more risks in your business, it is essential to have procedures in place in case one of those foreseeable incidents occurs. If there’s a likely risk of customer injuries on your premises (as would be the case of an ice rink with lots of new skaters, including young children), or employee injuries (for example, if you run a photo lab where injuries might result from chemical exposure), you should have clear procedures on how to handle any injuries that occur. Failing to have a plan in place for foreseeable accidents isn’t just irresponsible: It raises the likelihood that any such accidents might be worsened by your poor response. And it increases the chances that your business could face a lawsuit for damages.

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Put procedures in writing, and don’t make them overcomplicated. Simple checklists can be extremely effective. For example, the ice rink in the example above should consider preparing a checklist of “Yes/ No” questions for employees to use when a skater is injured. Your checklist should help ice rink employees answer an initial question about what constitutes a true injury and not just a painful fall. If the checklist helps determine that a fall does qualify as a true injury, the ice rink should have another procedure or flowchart of actions to be taken, such as 1) determining if the skater is conscious, and if not, calling 911, or 2) if the skater is conscious, asking the skater if he or she can recite his or her name and address. The flowchart should identify further steps to minimize the injury (such as putting ice on a swollen foot) and streamline the process of getting medical attention promptly.

Besides having procedures in place, it’s of obvious importance to make sure the appropriate staff are trained in how to implement them. Depending on lots of different factors, you might decide to train all staff, or just train department managers and give them the responsibility to train staff on the procedures.

A few simple checklists, step-by-step procedures, and/or flowcharts kept in a slim binder with enough copies for key staff and managers, and with appropriate training, can make a huge difference in protecting your business from a lawsuit. Injured customers or employees who perceive a system is in place to take care of them will be less likely to feel your business is to blame for their injury and therefore less likely to sue in the first place. And if they do sue, being able to show that you swiftly executed your well-thought-out procedures will go a long way in lowering your liability for injuries or damages.

Covering Employee Issues

Employees make businesses vulnerable. Every business owner who hires employees should be very concerned

about workplace-related liability issues and take steps to decrease the risks from possible claims and lawsuits. Lay the groundwork to hire carefully, train thoroughly, supervise adequately, have solid personnel policies in place, and maintain a safe working environment.

If you are unsure what your employment policies should be and what laws you must follow, check the Employment Law Assistance section of the U.S. Department of Labor website (www.dol.gov) and your own state’s department of labor. (Websites for state labor agencies are listed in Appendix A under “State Unemployment Compensation Agencies,” and on this book’s companion page on Nolo.com.) You can also consult a personnel specialist or HR manager, or review other employers’ personnel manuals to see what’s covered. Nolo (www.nolo.com) also provides good free information online.

With many workplace issues, the most effective risk management technique is to implement effective policies and training programs. For instance, straight- forward hiring and firing policies, including a written policy that employment is “at will,” help protect you against claims of discrimination and wrongful termination. A solid orientation and annual training program for employees on sexual harassment and discrimination issues will significantly reduce your liability exposure in those areas. Every business with employees should have written, posted policies to clarify what behavior is expected and what will not be tolerated.

Similarly, workplace safety issues can be addressed through training programs and posted materials. You can ask consultants who know your type of business to evaluate your workplace for compliance with the Occupational Safety and Health Administration (OSHA)—the agency that establishes and oversees workplace safety standards. Workplace safety will be an ongoing consideration and expense.

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Nolo Resources on Employment Law Matters

See the “Employment Law” section of Nolo.com (under “Free Legal Information”) for lots of useful articles on subjects covered in this chapter, including discrimination and drug testing. In addition to the articles, Nolo publishes comprehensive employment law books for small businesses on the following subjects:

• In-depth information about employment matters, including employers’ potential liabilities and employee lawsuits: The Employer’s Legal Handbook, by Fred S. Steingold; The Manager’s Legal Handbook, by Amy DelPo and Lisa Guerin; Dealing With Problem Employees: A Legal Guide, by Lisa Guerin and Amy DelPo; The Essential Guide to Federal Employment Laws, by Lisa Guerin and Amy DelPo; and Create Your Own Employee Handbook: A Legal & Practical Guide for Employers, by Lisa Guerin and Amy DelPo.

• Sexual harassment and illegal discrimination in the workplace: The Essential Guide to Handling Workplace Harassment & Discrimination, by Deborah C. England.

• Drug testing and privacy issues: The Manager’s Legal Handbook, by Amy DelPo and Lisa Guerin.

• Workers’ compensation laws and disability insurance: The Employer’s Legal Handbook, by Fred S. Steingold.

Beyond establishing and communicating personnel and other policies, your business needs to have enforce- ment mechanisms in place. The toughest written sexual harassment or safety policy won’t protect a business from a major lawsuit if there’s no one to complain to who has power to change the situation, or if complaints go uninvestigated and policies unenforced.

An “open door” policy and a safe channel to launch complaints are very helpful. Employees who understand that their employer is taking care of their concerns are less likely to become frustrated and sue.

In many states, you can ask the employee to agree to refer serious issues to a mediator and then, if they can’t be resolved within a reasonable time, to an arbitrator. A mediator is someone who helps people come to an agreement, while an arbitrator makes a binding decision. Some states automatically refer civil lawsuits to a mediator to see if the parties can settle before a judge will hear the case. Many employers have such an agreement in their personnel manuals that every new employee reads and signs.

It helps morale if the employer pays the costs of mediation and arbitration. After all, the employee probably has very little spare money, and a one-day mediation can commonly cost anywhere from $500 to $3,000. Some community mediation groups will take on small business claims for free or a nominal cost.

CAUTION

A lawsuit may still be possible. Agreements between employers and employees that make arbitration

the employee’s exclusive remedy are not always binding.

Judges do not like to see employees give up their rights

to complain to government agencies or to bring lawsuits,

especially if the employee has to agree to arbitrate future

disputes as a nonnegotiable condition of employment, such

as in a written employment contract. The law in this area

is changing rapidly, so you should find out what is legal in

your own state. For a good short discussion of mandatory

arbitration, see The Employer’s Legal Handbook, by Fred S.

Steingold (Nolo).

Deal With Problems When a problem does arise, stay as calm as possible while you get as much information as you need to decide what to do. You won’t do yourself or your business any good with an unconsidered response.

If a problem comes up in an area that is addressed in a written contract, a calm meeting or phone call is a good idea, followed up by a letter summarizing the meeting or conversation. Any meeting with a problem

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employee should be witnessed by at least one person who is neutral. If you are out of your depth, contact an expert such as an accountant, a lawyer, a doctor, an employment law specialist, or a mediator. Keep employment matters confidential.

Finally, realize that you might end up paying something to settle a claim or to defend yourself, whether or not you feel responsible for what went wrong. As discussed in Chapter 1, owners of sole proprietorships and partnerships are personally liable for all business debts, including damages stemming from a lawsuit against the business. It doesn’t matter much whether these owners are personally named or found liable in a lawsuit, or whether only the business itself is—either way, they’ll be personally responsible for paying the damages. This fundamental rule regarding sole proprietorships and partnerships is a major reason why many business owners choose to create an LLC or corporation.

If your small business is an LLC or a corporation (or if you are a limited partner in the business), then you, and owners like you, will ordinarily not be personally responsible for any damage awards against the business. Only business assets can be used to satisfy those debts. Of course, that could wipe out your business.

CAUTION

Personal guarantees may bind you. As a prac- tical matter, most suppliers and banks require a personal

guarantee from small business owners on contracts and

loans. This means that there will be personal, individual

liability on claims arising from those contracts. Similarly,

business owners will personally sign the document that

creates their businesses, so the co-owners can sue one

another personally on claims that arise out of starting,

running, or winding up the business.

All business owners—even owners of corporations and LLCs—may face personal liability in certain situations. Those who recklessly or intentionally cause harm may be found personally liable for injuries

caused by their actions. The same is true for business owners who don’t carefully investigate a deal before making a business decision.

Paying for What Goes Wrong

If you have been prudent, and if the business is reasonably successful, there will be some extra money in the bank for emergencies. There may be business assets, such as machinery or a building or inventory, that you can sell or pledge to raise money—subject, of course, to agreement by your co-owners. You may also have some insurance that applies. An insurance company has to pay for an attorney to defend you against a claim your policy covers. It will likely also pay some, maybe most, of any eventual settlement or judgment against you if the claim is covered by your policy. (Insurance is discussed in more detail below.)

Insurance and Warranties Insurance coverage is a powerful tool in risk management. However, there’s no requirement that you obtain property or liability insurance for your business, unless:

• your state requires liability insurance for a company vehicle

• state and federal law requires it because you have employees

• a contract job (usually with a government agency) requires the contractor (your company) to have a certain amount of insurance, or

• your lender requires it as a condition for getting a loan.

But just because you don’t have to get insurance doesn’t mean you shouldn’t. Even if you form a corporation or an LLC, which shields your personal assets from business liabilities (see Chapter 1), it won’t protect you from losing your business if disaster strikes. Careful as you may be, fate sometimes deals an unforeseen blow. If you face unexpected trouble, you’ll be thankful you’ve taken steps to protect yourself.

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CAUTION

Employers are subject to special insurance requirements. Employers must typically pay for workers’ compensation insurance and unemployment insurance. A

handful of states also require employers to pay into a state

disability insurance fund. All of these insurance programs

are specifically set up for employers and are largely regulated

by state agencies. (See Chapter 15 for some of the special

rules governing employers’ and employees’ contributions to

these insurance programs.)

There is an art to insuring your business: You want to get the maximum protection from insurance without blowing your whole bankroll on policies for every conceivable risk. Once you start to look, you’ll find every imaginable type of insurance policy out there, although your business will probably need only a few of them at most. The two most common and generally useful types of policies are property insurance and liability insurance. This section will explain the basics of these and introduce you to many other kinds of policies that cover specific risks involved in your business. It will also shine some light on the process of shopping for and buying the policies you need.

TIP

Caring for your policy. Treat your insurance policy just as the precious, and possibly irreplaceable,

document that it is. Store it carefully. Keep an old policy

even after you change insurance providers. A claim could

come up that arises from a long-ago event, and that

document may be your only way to track down an insurer

that you had in the past. Believe it or not, if the insurance

company or its successor is still in business and you have a

copy of the old policy to prove it covered that event, the

insurance company should provide the protection you paid

for at the time.

Property Insurance This chapter concentrates mostly on liability issues, but other types of losses can also be devastating to a

business. Property insurance can cover your business for damages or loss to your business property due to theft, fire, or other causes. There is a good deal of variation among policies on what property and what risks are covered and what the coverage is. Be sure you’re absolutely clear on these terms when you choose a policy.

You’ll want to make sure that your property insurance covers the premises themselves as well as the business’s assets that are kept there, including:

• fixtures to the property, such as lighting systems or carpeting

• equipment and machinery • office furniture • computers, telephones, and other office

machines, and • inventory and supplies.

Most basic property insurance policies will cover these items.

TIP

If you rent your business space. Your lease may require you to get a specific amount or type of

property coverage. Be sure to check your lease for any

insurance requirements before you purchase a policy. If you purchased your business property. You almost

certainly paid for title insurance, which protects you from challenges to your ownership of the property. You may also want to purchase a life insurance policy that is dedicated to paying the mortgage if anything happens to you. You usually get the best deal if you buy this on your own, not from your mortgage lender or broker.

You’ll need to understand not only which property is covered by your policy but what types of losses will be covered. Read it carefully to determine what causes of damage are insurable. Most general business property insurance policies will provide basic, broad, or special coverage—with special offering the broadest coverage and basic the narrowest.

A basic form policy will normally cover fire, explosions, storms, smoke, riots, vandalism, and sprinkler leaks. A broad form policy typically covers damage from broken windows and other structural

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glass, falling objects, and water damage. With both basic and broad form policies, certain risks may be listed as excluded—that is, not covered. Note that theft isn’t typically covered under either a basic or broad form policy, a fact that surprises many business owners. (See “Theft Insurance,” below.)

Special form coverage offers the widest range of protection, as it typically covers all risks—including theft—except for those risks that are specifically excluded. While premiums for special form policies are more expensive, it may be worth the added expense if your business faces unusual risks—or simply to make sure you’re covered against theft.

A basic policy may not cover the other property that you have at your business premises—for instance, if you rent a laptop or other equipment, or if customers leave their goods with you as happens at a jeweler, dry cleaner, or repair shop. If you expect to regularly have property that belongs to others at your business, get a policy that covers it.

If the policy you are considering excludes one or more items that you want covered, find out whether it can be included and at what cost. You may have to purchase what’s commonly called a “rider” or an “endorsement” to add special coverage to the policy. For example, accounting records, cash, and deeds are often excluded from standard property insurance policies but can usually be covered with some extra paperwork—and an additional premium.

You may find other ways to bring the property you want covered under the scope of the policy. For example, if you want the policy to cover your personal stereo that you keep at the office, but the policy only covers business property, one option is to transfer title of the stereo to the business.

Be sure that you clearly understand the dollar limits on your policy and any deductibles or copayments you’ll have to make. Also, make sure the policy covers the replacement cost of the property, not merely its depreciated value. Computer equipment, for example, loses value incredibly fast. If you lose your two-year-old computer to theft, you’ll definitely want your insurance to pay for a new computer rather than the value of the

stolen one, which might be barely enough to cover the shipping costs of a new machine.

CAUTION

Possible policy adjustments for home-based businesses. Owners of home-based businesses should figure out whether their homeowners’ or renters’ policies forbid

business use of the home or exclude coverage of business-

related claims. Make sure that your policy won’t be limited

or voided entirely by running a business out of your home.

It’s better to come clean with your insurance company

about your home business and maybe spend some extra

premium dollars than to find out after a catastrophe that

you had no insurance after all.

Liability Insurance Find out what an available “commercial general liability” (CGL) insurance policy will cover. Ask, for instance, whether it covers negligence—that is, carelessness or recklessness. Most CGL policies do not cover certain employment law claims such as harassment, discrimination, and wrongful termination. And all insurance companies will refuse to insure you against bad business decisions, criminal acts, or intentional acts of harm.

Personal Injury Liability Insurance

Say, for instance, that someone—a customer or supplier—puts a foot through a floorboard weakened by dry rot, trips on an electric cord, or is hit by a shelving unit that falls over. One accident like that could result in a verdict against your business for tens of thousands or even millions of dollars, even if you were only marginally at fault. For this reason, liability insurance is probably a wise investment for any business that has even minimal contact with the public.

Liability coverage insures you against the notorious slip-and-fall situation, when someone gets injured on your premises and sues you for the ranch. A general liability policy (versus a product liability or vehicle

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liability policy, discussed below) will cover damages that your business is ordered to pay to an individual, such as a customer, supplier, or business associate who was injured on your property.

Product Liability Insurance

A related, though technically different, type of insurance is product liability insurance, which protects you from lawsuits by customers claiming to be hurt by a product you made, sold, or provided. If your business has a product that has a risk of harming anyone, no matter how far-fetched, you might consider this type of insurance. Plaintiffs have won product liability lawsuits even when they were ignoring warnings or misusing the product. An insurance premium will be less expensive than a big award to a tragically injured plaintiff.

Auto Insurance

Auto liability coverage will not be provided by a general business liability policy, but it is legally required in most states. Even if it’s not required in your state, it’s foolish not to protect yourself against this potentially devastating risk. Insurance coverage for employees’ personal cars that are used for business is known as “nonowned auto” liability insurance. This protects your business if an employee hurts someone or damages property while driving his or her car on the job. If your employees will use their own cars for business activities, it’s important that you get this type of coverage even if your state doesn’t require it. Many nonowned auto liability insurance policies do not protect employees themselves, just the business; employees usually need to get their own coverage.

In addition, some states require drivers to be covered by other types of auto insurance, including personal injury protection (PIP) coverage and uninsured/underinsured motorist (UM/UIM) coverage. If your state mandates certain types of coverage, it will generally also require that you purchase a minimum level of the insurance. Check with your state’s department of motor vehicles to find out insurance requirements for drivers in your state.

Specialized Insurance Property and liability insurance are the two most important types of coverage for small businesses, but there are many other kinds of policies. Some of the more common ones are listed below. Keep in mind that a broad property or liability policy might already cover one or more risks listed here. For instance, if you have special form property insurance (discussed above), you’ll probably be insured against theft.

Employment Practices Liability Insurance

This is a relatively new kind of insurance. It can protect you against a number of employee claims including harassment, discrimination, and wrongful termination. It can be a very useful supplement to commercial general liability insurance.

Business Interruption Insurance

This type of insurance will cover you if your business is forced to close for a period of time for a reason covered under the policy, such as damage from a fire or earthquake. In that case, your policy will pay approximately what you would have earned if you had been open as normal.

“Key Man” Insurance

This is a life insurance policy that the business owns, pays for, and collects on. It protects the business when a crucial person dies unexpectedly and the business grinds to a halt. The “key” person whose life is insured can be the founder, the owner, or an employee—the person who knows everything and holds things together, especially in a small business. This insurance gives the business some extra cash that buys time to decide what to do: whether to hire a replacement, sell the business as a going concern, or wind down gracefully. It is similar in effect to business interruption insurance.

Malpractice Insurance

Often expensive, this type of insurance protects you from lawsuits arising from professional mistakes.

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Doctors, lawyers, real estate agents, accountants, and a number of other professionals typically need malpractice insurance. It is also known as “errors and omissions” (E & O) insurance.

Theft Insurance

Because many basic policies do not cover losses due to theft, you may want to purchase specific insurance to cover you in case office equipment is stolen. Be sure to find out whether the policy covers employee theft as well as ordinary burglary and robbery. If not, you can usually purchase that type of coverage separately.

Special Coverage

Other types of insurance include credit insurance for accounts receivable, insurance for intellectual property, such as trade secrets or patents, and dis- ability insurance for owners of the business. (This is not the same as state-mandated disability insurance for employees, discussed in Chapter 15.) Some businesses need insurance for issues that arise out of advertising, while others might need to guard against a big bill for environmental cleanup of purchased real estate. If you are an importer and travel frequently to dangerous foreign locations, you might want kidnap and ransom insurance. Talk with an insurance agent or broker about whether your specific business activities might warrant one or more of these special types of coverage.

Many corporations have special liability insurance called “directors’ and officers’” (D & O) insurance, because there are occasions when directors and officers are sued individually for making employment and other decisions. This comes up, for example, in sexual harassment cases. An insurance agent can tell you when a small corporation needs this type of coverage.

Investigating and Purchasing a Policy You have to do your homework to make an intelligent and cost-effective insurance purchase. You must understand both the large and fine print so you can

compare policies and purchase the best one for your business. For example, when comparison shopping among different insurance companies, it’s useless to compare two policies unless they cover the same types of property, the same risks, and the same payouts and deductibles. You can’t make an informed decision until you understand all these details.

Insurance brokers, who gather information from different insurance companies, can help you decipher policies and figure out your best deal. Make sure any broker you consult understands all the nooks and crannies of your specific business activities and the risks that may be involved. Try to find one who specializes in policies for your type of business. You may be surprised to learn that specially tailored policies already exist that cover your particular needs. For instance, a “producer’s package policy” for filmmakers covers several risks unique to the film business, such as the costs of production—often in the tens or hundreds of thousands of dollars—in case your negatives are destroyed. An insurance broker who knows your type of business will be able to direct you to these specialized policies, while a run-of-the-mill broker may not. Check trade magazines and websites for the ads of specialized brokers, and ask other business owners whom they use and what they buy.

You’ll probably encounter insurance companies that offer package deals that are cheaper than buying several individual policies separately. As long as all your needs are met—and not exceeded—these deals can be a good way to go. As always, be sure you understand the extent of coverage in each area rather than relying on any general promises that the package covers “all your business needs.”

RESOURCE

Finding help with business insurance on the Internet. A couple of websites that may be helpful are www.irmi.com, the website of the International Risk

Management Institute, and the Insurance Information

Institute’s website at www.iii.org.

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Manufacturer’s and Extended Warranties While insurance can protect you when property is damaged or stolen, product warranties can protect you in case equipment malfunctions for various reasons. Don’t overlook the value of warranties when considering ways to reduce risks and potential losses related to your equipment.

Most products come with a standard manufacturer’s warranty against defects for a certain period of time. Warranties generally range from 90 days to one year of coverage. It’s not uncommon for the warranty to cover parts and labor for different time periods—for example, parts might be covered for one year, and labor for 90 days.

In addition, you can purchase extended warranties for most equipment that offer coverage for longer periods, generally from two to five years. Though some manufacturers offer extended warranties to supplement the standard manufacturer’s warranty, many extended warranties are sold by companies other than the manufacturer. These companies make big profit margins on extended warranties, leading many consumer advocates, including Consumer Reports magazine (in a June 2012 article), to generally advise people against purchasing extended warranties.

The truth is there may be some situations in which purchasing an extended warranty makes sense for your business. Generally speaking, the more expensive and important a piece of equipment is to your business, the more an extended warranty might be a smart idea. For example, if your business cannot live without a certain piece of equipment such as a computer, and would be financially hard-pressed to replace it if it went south, an extended warranty might be a godsend—but always account for the repair time during which you won’t be able to use the equipment.

When considering whether to buy an extended warranty, be sure to consider the following factors.

Be clear about when the extended warranty coverage begins and how long it lasts. In particular, don’t pay for extended coverage that overlaps with the original

manufacturer’s warranty. If coverage begins as of the date of purchase of the extended warranty, as opposed to the date of purchase of the equipment, then wait until the original warranty is about to expire before purchasing the extended warranty. Most warranty companies allow this—but be aware that you will usually not be able to purchase an extended warranty if the original warranty has expired. Find out in advance what deadlines apply to the extended warranty purchase.

Make sure you trust the warranty company. Partic- ularly if the warranty is being sold by a third-party warranty company, evaluate the reputation and reliability of that company. If the extended warranty is being sold through a major national retailer, chances are it is not a fly-by-night scam—though it still may not be worthwhile. But be aware that scam warranty companies do exist.

Evaluate the value of the extended coverage. Weigh the cost of the extended warranty and what it will cover against the cost of the equipment and the likelihood it will need repair. Just as with insurance, warranties generally exclude certain types of damage from coverage. The more limitations on coverage, the lower the value of the warranty.

When you do have warranty protection, whether from an original manufacturer’s warranty or an extended warranty, it’s crucial to keep track of impor- tant warranty details—especially the expiration dates, so that you can purchase extended coverage if you so choose. As mentioned above, you will usually not be allowed to purchase an extended warranty if the original or previous extended warranty has expired— so be careful not to let those important dates slip by if you intend to purchase extended coverage.

FORM

Warranty Track Worksheet. The Nolo website includes a downloadable interactive worksheet to help you

track your warranty information. See Appendix B for the

link to this worksheet and other forms in this book.

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Simply enter all relevant information into the worksheet about warranty coverage for every piece of business equip- ment you buy. If you don’t have information for every column, it’s okay, but be sure to include the warranty expira- tion date. Keep the list sorted by “Warranty Expira tion Date” (Column C) in ascending order, so that the warranties about to expire will be at the top of the list. Make it a habit to enter this information as soon as you purchase any equipment, and to review and update the worksheet periodically so that you don’t miss any expiration dates and the chance to purchase extended coverage.

Chapter 7 Checklist: Risk Management

■■ Have active risk management strategies. Start by evaluating your risks and identifying specific ways to reduce them.

■■ If your business has employees, establish personnel policies, including hiring and firing guidelines, policies prohibiting sexual harassment and discrimination, and effective enforcement mechanisms.

■■ Research and purchase appropriate insurance for your business. Contact an insurance agent or broker familiar with your business to answer your questions and to price out various policies.

■■ Get a property insurance policy that covers against all the types of losses that your business may face, such as theft, fire, and water damage.

■■ Get a liability insurance policy if your business will have any contact with the general public, or if you determine there’s a significant risk that someone could sue your business for injuries or other damages.

■■ Get auto liability coverage for any vehicles used for business, including the personal cars of employees that are used for business.

■■ Consider other, specialized insurance coverage.

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