Liability Insurance Might Not Protect Your Business

Liability Insurance Might Not Protect Your Business

Many business owners with sole proprietorships or partnerships assume that obtaining liability insurance will afford you the same protections as if your structure was an LLC or corporation. However, while no business is immune from liability, whatever its structure, liability insurance does not replicate the full shield an LLC or corporation offers. Under a sole proprietorship or partnership, you and your business are considered the same legal entity, and you could be on the hook for liabilities incurred by your business--despite carrying liability insurance.

This is something we see a lot in our office when a sole proprietorship or partnership is slapped with a lawsuit and find that their liability insurance isn’t enough to make the problem go away. Here are the top three most common liability insurance gaps sole proprietorships and partnerships face, which could’ve been avoided if they’d instead formed an LLC or corporation:   

1. Policy Limits

Your policy coverage is capped, which means there’s always a risk that a judgment could exceed the policy limits. While liability insurance aims to indemnify the insured against any the agreed-to damages, the insurer’s coverage is limited. This seems clear enough since your policy explicitly lays out how much it covers. If your policy covers up to $500,000, you might think that you have more than enough coverage.

But, take for instance a catering business that uses a delivery van in the regular course of business. If the driver causes a wreck, and a passenger in the other car suffers extreme injuries, that could easily become a $1 Million judgment against the business.  $500,000 doesn’t offer much protection. You must come up with the rest of the damages, and any savings, property, and other assets you own could be at risk.

2. Exclusions

Insurance policies use exclusions to limit the range of the negotiated coverage by eliminating types of coverage. Exclusions are variable and numerous, applying to certain people, types of risks, or specific situations. While exclusions might seem like nothing to worry about, they can always come back to haunt owners.

Exclusions have exposed many a sole proprietor to liability. For example, there was a recent case  in Houston where a sole proprietor filed a claim for his insurer to pay the damages he had incurred from a car accident he had caused during business operations. The insurance company refused the claim because of a policy exclusion that barred coverage for any injury or damage caused by anyone using a car owned by the named insured. Despite the owner’s argument that the exclusion did not apply because he owned the car individually, the court found the distinction irrelevant because, under Texas law, a sole proprietor and his proprietorship are the same legal entity. As a result, the owner was solely responsible for paying damages.

3. Lapses in Coverage

Even if you have an excellent insurance plan with substantial coverage and minimal exclusions, letting your coverage lapse can spell disaster for small businesses. Lapses in coverage could cause the insurance company to see you as high-risk, which means they could raise your premiums or drop you altogether, leaving you scrambling to find a new insurer. Should your insurance coverage lapse, even if for only a short window, you won’t have coverage for that period and you will be solely responsible for liability that arises during that window.

While it may seem wise to put your faith and trust in liability insurance, you surrender much of your ability to protect yourself and your assets. You can always argue your case in court, but win or lose, you will have spent a lot of time, effort, and money when you were trying to avoid that outcome.

What other concerns do you have about the extents of liability insurance coverage for sole proprietorships and partnerships? Want to know more about how LLC and corporation structures can avoid those liability gaps? Ask us how we can help you protect your assets and investments from the ground up by choosing the smartest business structure for your needs.

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