I will be the first to admit the subject of practical business planning is not always high on the “to-do” list for most webmasters. Practical issues such as incorporation are necessary acts, but not all that exciting. If you incorporate, however, does this mean you still need insurance?
Insurance vs Incorporation
When creating a site, the vast majority of business owners make a very simple mistake. They try to decide whether they need to incorporate or just purchase insurance? This is the wrong approach. Incorporation and liability insurance are complementary forms of protection. Each provides plenty of benefits to the business in question, but each also has gaps that can be exploited by creative lawyers. When used jointly, maintaining insurance and a business entity should provide you with a very strong shield between your personal assets and the debts and liabilities of the company.
So, what are the gaps I mentioned above? Let’s look at a situation where a business is incorporated, but has not taken out a general liability insurance policy.
Let’s assume I start a site with a forum. A person joins my site and then post photos to the forum. I am not in compliance with the Digital Millennium Copyright Act, so I am sued for copyright infringement. I’m facing potential liability in the amount of $150,000. If I lose the lawsuit, the corporation should provide a shield between the business debts and my personal assets. This, however, is not the full story.
How am I going to pay for the defense of this lawsuit? It is a very simple question, but one that sinks many defendants. The total cost of defending a lawsuit when including the lawyer fees is going to be in the range of $50,000 to $100,000. Unless you’ve planned ahead and set aside a significant amount of cash, this cost could cripple you before the lawsuit even starts.
Now let’s look at the same situation, but with the added fact I also carry general liability insurance. The first thing I’m going to do is contact my insurance carrier if a lawsuit is filed against me. The insurance carrier will then assign my lawsuit to a preapproved lawyer. This lawyer will go ahead and defend my business in the lawsuit. The insurance company will pay for this defense. On top of this, the insurance company will pay any judgment returned against my company.
Is insurance necessary if I incorporate? Yes and this example shows why it is a smart move.
At this point, you might be wondering why it’s necessary to incorporate the business if insurance is going to take care of the costs of defense and pay any judgment rendered in the case. There are a couple of reasons. The first is insurance companies don’t always stand up and deliver on the policies they provide. You can read about an example here.
You can also run into a policy limit problem. Let’s assume you are sued for $5 million but have a $1 million insurance policy. The insurance company will only be required to pay $1 million of any judgment against you. Anything above that amount will be your responsibility. In such a scenario, your decision to form an entity at the outset of your business venture saves you from losing all your personal assets.
Let’s revisit our original question. Do you need insurance if you are incorporated? There is no legal requirement, but it is a sage move.
Richard A. Chapo, Esq.