Legal proceedings can be very intimidating for businesses, especially for those who are unprepared. A lawsuit and a settlement or judgment looks slightly different for each business structure. It will also vary depending on the nature of the claim, whether you have insurance, and who is asserting the lawsuit.
Planning ahead can save you and your business from having to file bankruptcy in the future. Knowing just how a lawsuit will play out in each business type will help you determine what legal structure will work best for your situation.
No matter what type of business structure you have, the general outline of litigation remains the same. Most lawsuits will involve the following steps after the claim is filed with the court:
Lawsuits only affect business structures differently after a plaintiff gets a judgment. If you win your case and do not owe any money, then the type of business structure you have will not make much difference.
However, because upwards of 90% of cases settle, there is a good chance that once a case starts, your company may have to pay something to conclude the litigation. Of course, paying attorneys’ fees to defend a lawsuit can take a severe financial toll on some businesses. How that affects you personally will depend on the type of business structure that you have.
Most small businesses that are run by just one or two people are sole proprietorships. In fact, solo companies are the most common business structure in the United States; there are 23 million sole proprietorships in the United States. In comparison, there are just 1.7 million traditional corporations. Partnerships are less common than sole proprietorships, but there are still roughly 7.4 million of these businesses throughout the United States.
This stark difference between the number of solo businesses and partnerships compared to corporations is, in large part, because sole proprietorships and partnerships take virtually no effort to form. You do not even need to pick a new name for your business. In fact, some business owners who run sole proprietorships think of their venture as more of a hobby than a real company. However, just because you think of your business as a hobby does not shield you from legal liability.
From a legal perspective, you and your sole proprietorship are one in the same. This is true even though you may have different bank accounts or even operate under a different name. Nothing is protecting your personal assets from your business debts or liabilities. That means that if your business gets sued, everything you own is at risk. It also means that it is particularly important to know and understand the risks associated with your type of business.
The type of business that you operate will dictate what kind of risks are important for your company. For example, a venture that helps people repair and maintain their vehicles will have very different risks compared to someone who provides consulting work for engineering projects.
To determine the potential legal exposure for your business, think about the various ways that someone could be physically or financially harmed by what you are doing, as those are the most common reasons that lawsuits will begin. Some examples include:
Every company is different. What may be a big concern for your industry may not be an issue for other business owners.
Once you determine that a suit may be in your future, it is a good idea to talk to an attorney about your exposure. Defending a lawsuit can be very expensive, but if you are able to stop the suit before it happens by negotiating with the potential plaintiff, then that can save you considerable time and money in the long run.
If you lose a lawsuit and the plaintiff gets a judgment against you, keep in mind that it will affect more than just your business—it will often take a toll on your personal assets as well. The same concept applies to partnerships. Once a plaintiff has a judgment, he or she may be able to garnish your bank account, seize assets, put liens on your real estate, and more. Each partner will face the same liability unless the lawsuit falls into some rare exceptions for fraud or misuse of funds.
Because lawsuits for sole proprietorships can force a business owner into bankruptcy, having business insurance to protect against a variety of situations that may affect your business is critical. When you are adequately insured, your insurance company will not only help pay the plaintiff for their losses or damage, but the insurance company will also usually pay for the cost of your defense as well.
There are two general types of limited liability businesses: limited liability companies (LLCs) and limited liability partnerships (LLPs). Limited partnerships (LPs) also fall under this umbrella, but they are not as common.
These businesses require that you register with the state using articles of organization and meet specific guidelines to develop and maintain the company. Because of these additional procedural hoops, these business structures are far less common compared to general partnerships and sole proprietorships.
Perhaps the most important benefit of having a limited liability business structure is that only the assets of the company are at risk if a plaintiff gets a judgment. As long as the company is maintained properly, liability for business actions and dealings should not affect your personal assets.
However, if there is overlap between, for example, your business account and your personal account, then your personal assets could be at risk. It is critical to maintain the company’s separate identity if you want to ensure that the liability stops at whatever you have invested in the business.
There are two basic types of corporations: C corps and S corps. C corps are the more traditional corporate structure. They have their own separate tax rate and are accompanied by many filing and administrative requirements. They work well for large businesses but may make sense for some small businesses as well. As an alternative, many companies choose to operate as an S corp because it offers tax advantages and does not require as many corporate formalities.
Both corporate structures offer limited liability for those who own shares in the corporation, sit on the board, or manage the company. That often means the most money that you can lose as a corporation owner is the value of your shares in the company. However, there are situations where the S corporation will pass losses through to shareholders. If a lawsuit resulted in a loss, then the S corporation’s owners may be indirectly affected.
Once you are ready to form your business, you can use LegalNature’s business formation documents to get you started. Every document is created by attorneys who know the laws in your particular state so you can be confident that they meet local filing requirements—and you do not have to involve an attorney in the process. Get started by visiting our legal documents section.