“You’ve Been Served!” – 4 Pointers on Lowering Litigation Risk in Your Business

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By Paul J. Franzetti

“You’ve been served!”  Those three words strike fear into the heart of any rational person.  Being sued is not only a hassle but it puts your hard-earned assets or business at risk.  We live in a litigious society, however, and every business owner should think about these risks.

So, how should you handle the risks?

First, form an entity that limits your personal liability.  The choices in Texas include corporations, limited liability companies, and limited partnerships, along with professional versions of each.  Each of these forms requires initial filings with the Texas Secretary of State, as well as filings for certain updates and annual filings and tax payments to the Texas Comptroller of Public Accounts.

A comment on another type of entity – a simple partnership – is in order.  Forming a simple partnership to engage in business with others does not require these filings but it also does not insulate your personal assets in the event of a lawsuit.

The overwhelming entity of choice these days is a limited liability company – that is, an LLC.  Two of the most important benefits to a small or medium-size business of an LLC over a corporation are that

  1. profits from an LLC’s business can be taxed once at the owner level rather than at the entity level and the owner level as in the case of corporations; and
  2. the “deal” among the owners of the business (if more than one) can be more easily customized on a variety of issues than for a corporation including among them buy-outs, profit distributions, and control factors.

A corporation, however, can still have their place as a business grows and even a new business owner should not overlook the potential for the benefits of the corporate form.

But forming an entity is only the first step.  You must make sure that the entity, and not you, is doing business with customers and suppliers.  This typically involves making sure contracts are in the name of the entity and avoiding, if possible, giving personal guaranties on those contracts.

An entity also involves keeping up company formalities and keeping the entity in good standing.  The formalities may be required by law or they may be an aspect of the criteria that lenders or investors use in evaluating your business.  If you do not maintain the formalities required by law, you could still be personally liable on company debts.  If you don’t maintain the formalities that lenders or investors use as part of their criteria, your company may not obtain a loan or investment when it is needed.

Second, keep your business assets separate from your personal assets.  As implied above, forming the entity is the first step.  You must maintain separate bank accounts and formally declare dividends when taking money from the corporate account to pay for personal expenses.  Likewise, investing personal money in the business should be documented as a capital increase or a loan.

Third, obtain liability insurance.  Not every matter that could turn into a lawsuit can be insured against but it is silly to ignore those risks that can be insured.  While your entity should protect your assets outside the business, it will not protect them if you commit a tort.  For instance, what if a visitor to your office or premises is injured?  A court could determine that you were negligent for not fixing a defect that was the cause of the injury.  That determination would subject your personal assets to a judgment.

Fourth, engage early on when a customer or supplier has an issue.  Addressing an issue early usually signals to the customer or supplier that you are doing everything possible to resolve the issue and this often avoids being sued.

None of these will absolutely shield you from the risk of being sued.  But, doing them may well solve your issues on this point and not doing them only invites trouble down the road.

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Paul J. Franzetti is the Founder of Paul J. Franzetti, Attorney at Law.  He can be contacted by phone at 713-242-1265, by email at pfranzetti@trustedlawadvisor.com, or visit his website at www.TrustedLawAdvisor.com.

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