Liability of Owners: Everything You Need to Know
Liability of owners is a concept for small business owners to understand as it describes their personal legal responsibility for business debts and lawsuits.3 min read
Risks of Unlimited Liability
Business owners who do not protect their personal liability may be subject to four different categories of risk: business, financial, unsystematic, and systematic.
- Financial risk occurs if the business defaults from obligations to lenders and creditors. If the business itself cannot meet these obligations, the business owner is responsible.
- Business risk occurs if the business does not generate the cash flow to meet its operating expenses. If vendors and service providers cannot be paid, the owner must close the business.
- Systematic risk is the risk for all business owners in a down economy.
- Unsystematic risk is the industry-specific risk for business owners in an economic downturn.
Common Business Liabilities
A liability is any financial obligation of your business. Some of the most common business liabilities for which an owner can find him or herself personally responsible include:
- Loans, mortgages, and other types of debt
- Income tax and other taxes payable
- Employee wages and salaries
- Prepayments and deposits
- Personal injuries that occur on the business property
- Employee injury that results from lack of safety training or neglect of safety regulations
- Injury caused by a defective product
- Violation of wage laws
- Malpractice and other forms of negligence
- False advertising
- Leaking customer or employee data
- Environmental damage
- Negligence of local zoning laws
- Violation of intellectual property laws
If your business is sued, it doesn't necessarily mean you will be found guilty. It's important to retain an experienced attorney who can protect your business and personal interests.
The Role of Business Structure
Creating a separate legal entity for your small business is the first step to separating your personal liability from your business liability. If you are running a business but have not established a legal structure, you own either a sole proprietorship or general partnership by default. Although these are the most basic business structures, they do not provide legal separation. That means if your business gets sued, you are personally getting sued. Your personal property, savings, and assets can all be seized in a court judgment if you are found at fault.
A limited liability company (LLC) is relatively simple to establish and manage and provides limited liability, which means that you are not personally liable for business debts and obligations beyond the amount of your investment in the business. That's because an LLC is legally recognized as a separate entity.
However, even with an LLC, you can still be found personally liable for business debts if:
- You have provided a personal guarantee for a business loan.
- You have signed a business contract not in the name of the business, but in your own name.
- You commit a crime in the course of running your business.
- You injure someone in the course of business.
- You do not maintain your LLC in good standing. This requires you to keep up with annual fees and filings as well as to keep separate accounts for your business and personal finances.
Business Liability Insurance
Purchasing this type of policy can insulate your small business from property damages or personal injury lawsuits. The exact business liability insurance you need depends on the type of company you have, so it's important to consult an insurance agent who is familiar with your industry.
The three main types of business liability policies include:
- General liability insurance to protect against property damage, advertising claims, negligence claims, and personal injury claims. Many businesses only need general liability insurance.
- Product liability insurance protects you if you manufacture and sell a defective product that causes injury.
- Professional liability insurance protects against omissions, negligence, errors, and malpractice for businesses which provide a service.
Some types of professionals, such as doctors and lawyers, are required to have business insurance.
If you need help with business owner liability, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.