So you’ve been hit with an expensive errors and omissions claim. You have an idea about what to expect from this kind of lawsuit (and if you need a refresher, read “Understanding Malpractice / Errors & Omissions Lawsuits”). But now you’re wondering how you’re going to pay for all your legal defense expenses and any settlements or judgments made against your business.
There are a few options for generating the funds your business needs to survive a costly legal entanglement. Here, we’ll rank your small business’s professional liability lawsuit funding options, ranked from most viable to least:
Purchase an Errors & Omissions Insurance Policy
The easiest way to ensure you have the finances to weather a professional liability lawsuit is to purchase Errors and Omissions Insurance. You won’t even have to worry about hunting down a malpractice attorney as most of these policies include a “duty to defend” provision. That means you’ll enjoy…
- Having your insurance provider orchestrate your legal defense on your behalf.
- Securing financial coverage for your legal defense fees, settlements or judgments, and other court costs.
E&O Insurance is likely your most cost-effective option for mitigating unexpected lawsuit expenses. In exchange for a relatively affordable premium, you have access to millions of dollars’ worth of coverage.
Plus, having your own policy allows you to stay in control of your business’s future. You don’t have to bank on the charity of others or liquidate your assets to settle your losses.
Create an Account for Legal Defense Costs
Though having Professional Liability Insurance is your best lawsuit-funding option, you could feasibly set money aside every month in a personal legal defense fund. Usually, a “legal defense fund” refers to nonprofit charities that help pay for public litigation efforts. While these kinds of funds are tax-exempt, yours will not be because it is for your business’s interests.
This option may sound appealing at first, but consider this: between the costs of running your business, paying your employees, paying commercial rent and loans, and covering utilities, chances are you won’t be able to set aside enough to cover a $100k settlement or judgment. That’s why instead of squirreling away a little extra each month, your money would go further if you put that toward an E&O premium.
Borrow from Friends and Family to Pay a Lawsuit Debt
If you are fortunate enough to have friends and family with deep pocket and a charitable mindset, you might have some success pooling together resources to pay for your E&O lawsuit costs. However, relying on the kindness of others is a tenuous business protection strategy at best. After all, you never know when your friends and family will fall on hard times themselves.
Settle Professional Liability Losses with the Bankruptcy Option
Bankruptcy is a heartbreaking and stressful route – and an expensive one, too. According to an article by Entrepreneur, lawyer and court filing fees alone can quickly climb to $8,000 or $9,000. Plus, filing for bankruptcy hurts your business and personal credit scores for years to come.
Only consider bankruptcy as an option if…
- Your bank account is drained.
- You don’t have E&O Insurance.
- You owe a debilitating amount of money toward a settlement or judgment.
Even if all three conditions are true, filing for bankruptcy may not be your best option. There’s no guarantee you can keep your house or other property. At the best, it can only buy you time.
If you’re a sole proprietor, you can file for Chapter 13 or Chapter 7 bankruptcy, which can be used for personal debts or business debts. If you’re an LLC owner, filing bankruptcy may not protect your personal property from collection if you’ve pledged your personal assets as collateral.
Here are the differences between filing options:
- Chapter 7 bankruptcy. This allows you to sell your assets (save for property that's exempt under state or federal law) to pay off your debts. You only want this option if you’re trying to make a clean break from your failed business. Chapter 7 eliminates any unsecured business debts (such as lawsuit judgments). However, your credit rating will be negatively affected for several years.
- Chapter 13 bankruptcy. You’ll use your income to pay off your losses after you propose a plan to pay off your debt over three to five years. The upside is that you don’t lose your property when filing for Chapter 13. Your credit will still be negatively impacted, though.
As you can see, both of these options should only be last-ditch efforts to scrap or salvage your business. Filing for bankruptcy is by no means an option you should plan to take. And it’s worth noting that some judgment liens can remain attached to your property even though you filed for bankruptcy (e.g., a lien on your house).
You can read more about bankruptcy in Nolo.com’s article “When You Can't Pay Your Business Debts: Personal Liability and Bankruptcy Options.”
On Lawsuit Loans and Why They Won’t Work
Lawsuit loans are cash advances given to claimants by a third party before a case is settled. In exchange, the lender receives a percentage of the judgment or settlement. If a case isn’t successful, the lender could lose money. For this reason, the third-party lender is usually very selective about the cases they fund, opting for the ones with the highest probability for success.
If you’re wondering whether you can get lawsuit loans to cover yourself when you’re sued, the quick answer is no. These “loans” are only available to plaintiffs (i.e., the person filing the lawsuit against another person or entity). Defendants (those on the receiving end of a lawsuit) aren’t usually funded.
And that may be a blessing in disguise. These loans usually have exorbitant interest rates attached to them. In some cases, interest and fees escalated to 76 percent of the loan amount in the first year. (Read more about that in “Lawsuit Loans Add New Risk for the Injured” by the New York Times.)