How to Protect Your Small Business from a Lawsuit

As a small business owner, you face the risk of a lawsuit every day. It can cost money, time, your reputation and cause stress. Lawsuits can also put some companies out of business.

It may not be possible to avoid every legal claim against your business, but it's important to limit your risk of a lawsuit. Following these good business practices may help protect you and your interests.

1. Maintain written agreements and records

Start by making sure your business records are well maintained. Should a dispute arise, accurate records may be helpful in avoiding a lawsuit.

Yet, even the best of intentions can fall short. It can be difficult to know what records to keep and how to store them. A records management plan may be helpful in maintaining records and keeping them up to date.

An attorney can tell you what formal contracts you need. These may include employment contracts and general sales and supplier agreements. You may also want to capture important details for every business transaction. For example, document the services or products you provide, the price and the delivery date. Keep related records, including emails and notes from phone conversations.

Maintain records of contracts, agreements, inventoried assets and their coverage. Make sure to get all business agreements in writing. Keep them as part of your records management plan.

The following are some suggested categories of documents to consider retaining:

Employee records

Your employees are your greatest asset, and it’s important to maintain employee documentation. You are also obligated to keep certain employee records. Some of the most important documents to maintain include:

• Work authorization: I-9 forms.
• Payroll documentation.
• Employee agreements and contracts: employee handbooks, policies and nondisclosure agreements.
• Personnel records: performance appraisals, payment records, disciplinary records and promotions.
• Records of recruiting practices.
• Family and Medical Leave Act (FMLA): Maintain documentation of all FMLA leave requests and related files.
• Accidents, exposures and workers compensation records.

Tax documents

The Internal Revenue Service (IRS) advises that businesses maintain documents that reflect business activities.¹ These include supporting documents from purchases, sales, payroll and other transactions. The following are some of the types of documents you should keep for tax purposes:

• Gross receipts.
• Purchases.
• Expenses.
• Travel, transportation, entertainment and gift expenses.
• Assets.
• Employment taxes.

Keep all records of employment taxes for at least four years after filing the fourth quarter for the year.²

Legal documents, business agreements, contracts

It’s wise to also maintain records that document the establishment of your business. Retaining corporate records helps show that your business is following its articles of incorporation, bylaws and charters. Other types of corporate documents to maintain include:

• Corporate financial records: stock ownership and transfers, bylaws, capital-stock certificates, dividend registers and canceled dividend checks.
• Founding documents: articles of incorporation, business names, corporate, partnership and limited liability corporations.
• Business licenses and permits.

These documents should be a permanent part of your records management plan.

Supporting business documents

Purchases, sales, payroll and other transactions generate supporting documents. These include sales slips, paid bills, invoices, receipts, deposit slips and canceled checks. These documents contain the information you need to record in your books.³ Organize them by year and type of income or expense.

Electronic files

Don’t forget that electronic files are as important as paper documentation. Maintaining digital documentation can help save physical storage space and retrieval time. 

2. Protect your reputation

Businesses run on reputation. Be upstanding in your dealings with employees, customers, competitors and the community. If you say you’re going to do something, do it. If you make a promise, keep it. Don’t bend the rules or misrepresent your business, products or capabilities. Doing so could harm your business, causing mistrust, lost business and potential lawsuits. Lay a foundation for your business to prosper by acting with honesty and integrity.

3. Employ sound employment practices

There are many state and federal laws that govern the workplace. These include laws on workplace harassment, discrimination and your employees’ privacy rights. It’s important to be familiar with and adhere to these laws. Employment Practices Liability+^SM Insurance can help. This is coverage for employee claims related to wrongful employment practices.

Make sure you recognize which laws apply to your business and learn about the requirements of each. Then create and enforce policies to help ensure that you comply. A human resources consultant or employment lawyer can be helpful in this area.

4. Be prepared with an experienced lawyer

Having a lawyer to consult can help prevent you from heading down the path to a lawsuit. You may want to have a lawyer on retainer before you face an unforeseen legal issue.

Take a proactive approach by finding a reputable lawyer with the expertise you need. Consider a lawyer who is:

• Knowledgeable about matters associated with the type and size of your business.
• Capable of helping you stay compliant with the law and anticipating legal issues.

Finding a lawyer for your small business

There are services that you, as a business owner, can turn to for legal guidance. Start with the American Bar Association’s (ABA) state-by-state lawyer referral directory.⁴ Many state bar associations also offer certified lawyer referral programs online.

Though bar associations are good options in your search for an attorney, you may still need to find an attorney that specializes in your specific business needs. Ask for referrals from friends, relatives or business associates. Reach out to other small business owners in your community. Sometimes, word-of-mouth suggestions can yield good results in your search. Also look for small business advocacy groups that are membership organizations, such as the National Federation of Independent Business (NFIB).

You can also find business attorneys who volunteer their time and expertise through nonprofit organizations, including those who focus on new and low-income businesses. Search online for “small business legal help” to find options.

5. Separate your personal finances from your business

Your business structure can affect asset risk, taxes, operations, legal protections and benefits. That’s why choosing the right business structure, even for small businesses, is crucial.

Small business structures 

What are your options? The following are common small business structures.

• Sole proprietorship: A sole proprietorship is the easiest type of business structure to establish. This structure gives you complete control of your business.
  
  Conducting an unregistered business establishes your enterprise as a sole proprietorship. But depending on your business and location, you may need to register a “Doing Business As” (DBA) and/or obtain certain business licenses.
  
  One drawback to a sole proprietorship is the lack of protection. You are responsible for all liabilities. If you decide on a sole proprietorship structure, a general liability or business owner’s policy (BOP) can be invaluable in covering you and your business against liability claims and lawsuits. Examples of lawsuits that businesses face include copyright infringement, injury and faulty products that caused property damage.
• Limited liability company: A limited liability company (LLC) is designed to protect you from personal liability. In most instances, your personal assets – such as your vehicle, house and savings accounts – won't be at risk in case your LLC faces bankruptcy or lawsuits.
  
  Members of an LLC are considered self-employed. Seek professional tax guidance on self-employment tax contributions toward Medicare and Social Security. Again, General Liability and a BOP are good coverages to consider in this type of business structure.
• Partnership: A partnership consists of two or more people who start a business together. There are general partnerships, limited partnerships and limited liability partnerships. Typically, each person contributes money, property, labor or skill, and shares in the profits and losses of the business. A formal partnership agreement can help spell out responsibilities and expectations.
  
  In a partnership, personal assets are not protected from liability and potential lawsuits. The general liability insurance that is part of a BOP can help protect the assets of the partners.
  
  There are two common types of partnerships: limited partnerships (LP) and limited liability partnerships (LLP). Limited partnerships have only one general partner with unlimited liability. All other partners have limited liability. The partners with limited liability also tend to have limited control over the company, and this is documented in a partnership agreement. The LP passes profits to personal tax returns, and the general partner – the partner without limited liability – must also pay self-employment taxes.
  
  Limited liability partnerships are like limited partnerships but give limited liability to every owner. An LLP protects each partner from debts against the partnership. They are not responsible for the actions of other partners.

6. Know your insurance coverage needs

Another way to help reduce the financial impact of a lawsuit is with insurance. General liability insurance, typically part of a BOP, covers many risks for small businesses. These include claims against a business related to bodily injury (for example, slips and falls) and property damage. They also include claims related to advertising injury (for example, copyright infringement).

Commercial auto insurance can help protect your business and your employees against liability for driving-related accidents. It can also help cover the costs of physical damage to your business automobiles.

Depending on your business, you may also benefit from more specialized insurance. If your business offers professional advice or services to clients, professional liability insurance can help cover the cost to defend your business if a client sues, claiming damages from an error or omission in the services you provided.

You may also want to consider umbrella insurance. This provides protection beyond the coverage limits of your primary liability policies. Umbrella insurance can help pay for large, unexpected covered losses.

If a claim is made against your business, notify your insurance company as soon as possible. Early reporting may help resolve your claim quickly and avoid lengthy legal entanglements that may cost you time, money and your reputation. Preserve records and evidence. These might be helpful in defending your case and even help prevent further damage.

Find an agent today to learn more about specific coverages that can help you protect your business.

This information is not intended to constitute legal advice – the information, content and materials referenced above are for general informational purposes only.

Sources

^1,3 https://www.irs.gov/businesses/small-businesses-self-employed/what-kind-of-records-should-i-keep, Page Last Reviewed or Updated: 17-Mar-2023.

² https://www.irs.gov/businesses/small-businesses-self-employed/employment-tax-recordkeeping, Page Last Reviewed or Updated: 07-Jul-2022.

⁴ ABA Lawyer Referral Directory