Liability Protection - Business Entities and Malpractice Insurance
Law firms face liability risks from several directions. Like all small businesses, a firm can be sued by someone it does business with. It can be sued by a person who is injured on the firm’s premises. And it can suffer damage from a fire or flood. Lawyers also have more unique risks: malpractice claims and the possibility of confidential client information being leaked in a data breach.
Business and malpractice insurance can protect against some of these risks. For others, you want the protection offered by forming a business entity.
Business Entities 101
If you’re a solo lawyer and you don’t set up a business entity, you are considered a sole proprietor. If you have law partners, your firm will be a general partnership. Sole proprietorships and general partnerships don’t have any identity of their own – the business owners and the business are one in the same. If the law firm is sued, you and your partners will personally be on the hook for any judgment. If your law partner is sued over something you weren’t involved in, you will also be responsible.
When you set up a business entity such as a limited liability company, a limited liability partnership or a professional corporation, your personal liability for business lawsuits is limited to the amount of money you have invested in the firm. You no longer have unlimited personal liability for lawsuits against the firm, or for torts committed by your partners and employees. You are, however, still fully liable for your own torts.
The types of business entities available to a law practice may vary depending on the state you live in. Possible choices might include professional associations, professional corporations, limited liability partnerships and limited liability companies. Although all offer limited liability protection, their tax treatment can vary. It’s a good idea to get professional advice before choosing an entity type.
In addition to forming a business entity, you should have an operating agreement, buy sell agreement or other agreement between the law partners that governs management of the practice and how to handle new and departing members and sale or closure of the firm. Establishing these sorts of agreements at the outset can help avoid bitter and costly disputes among the partners later.
Malpractice insurance can be costly, but it is the only way to protect yourself against a client’s claim that you were negligent in handling a case. Forming a business entity won’t protect you from your own torts, including malpractice.
Malpractice insurance typically includes the cost of defense as well as payment of any eventual judgment. Pay close attention to the limits in your policy, since the insurer may include both defense costs and the judgment in calculating whether you have reached your limit of coverage.
A business owner’s policy can provide general liability insurance to protect you against personal injury and other claims, property damage insurance, and business income insurance that covers lost income due to property damage. Because law firms are entrusted with a large amount of sensitive personal data, an increasing number of firms are taking out cyber liability policies that cover the cost of fixing a data breach.
A business insurance agent who specializes in law firms can help you identify the types of insurance your firm needs. Check with your local bar association or other lawyers in your area for malpractice insurance recommendations.