Chapter 2: Dealing with Errors and Omissions Lawsuits
Part 4: Lawsuit Funding Tips for Small-Business Owners
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. But now you're wondering how you're going to pay for all your defense fees 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 discuss your small business's lawsuit funding options, ranked from most viable to least:
Option 1: Purchase an Errors and Omissions Insurance Policy
The easiest way to ensure you have the finances to weather an E&O lawsuit is to purchase Errors and Omissions Insurance. When you have an active policy, you don't have to worry about hunting down an attorney, as most of these policies include a "duty to defend" provision. That means you'll enjoy…
- Having your insurance provider orchestrate a legal defense of the charges against you.
- 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.
Option 2: Create an Account for Legal Defense Costs
Though having 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.
Option 3: Borrow from Friends and Family
If you are fortunate enough to have friends and family with deep pockets and charitable mindsets, you might have some success pooling resources to pay for your E&O lawsuit costs. However, relying on the kindness of others is a tenuous business protection strategy. After all, you never know when your friends and family will fall on hard times (or change their minds).
Option 4: 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.
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 for 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.
A bankruptcy lawyer and filing fees can cost as much as $9,000.
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, 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 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 ."
Next: Part 5: Don't Waste Time with Lawsuit Loans