Business owners who form corporations or limited liability companies (LLC's)
may question the need for the business to carry insurance. A major benefit of
these forms of business organization is that they shield the owners' personal
assets. Because of this, the owners may believe insurance is unnecessary.
A corporation is a legal entity separate from its owners. It acts as an
artificial legal person. It can do the things that individuals may do, such as:
- Enter into contracts
- Incur debts
- Earn income
- Make investments
- Sue others and be the target
It gives its owners a legal shield against many of its obligations. In other
words, an individual owner of a corporation (called a "stockholder")
does not have to pay for the business's debts out of his own funds.
An LLC also shields its owners (known as "members"). However, tax
laws apply differently to LLC's than they do to corporations. If a corporation
earns $10,000 in income, it must pay tax on that $10,000. If an LLC earns
$10,000, the money is distributed to the members and they individually pay
taxes on it.
Corporations and LLC's shield their owners and members from liability for
the entity's debts. Suppose someone sues the business, claiming that its
product injured him. A court orders the business to pay the injured man
$1,000,000. The business must pay that amount out of its assets. However, the
individual owners or members do not have to cash in their bank accounts or
homes to pay it. The most they stand to lose is the amounts of their
investments in the business.
The shield is not absolute. A court may hold individual stockholders and
members liable in some situations. If they personally and directly injure
someone, the shield does not protect them. It may also decide that the
corporation is a sham entity. It could do this if the business has not
conducted the normal activities of a corporation, such as:
- Holding regular stockholder
- Keeping business records
separate from those of the owners
- Investing adequate capital in
Regardless of the shield, the business should carry insurance. The shield
cannot protect the time and effort that goes into building a business. An
uninsured accident can wipe out all of the business's assets. Without large
additional investments, the business might not survive. The stockholders'
investments in money, time and work will have been wasted.
Also, an individual acting on the business's behalf may incur personal
liability. For example, while driving on company business, a member may injure
someone in a car accident. Business liability and auto insurance policies
usually insure individual stockholders and members for acts they perform in
their roles with the business. Without this coverage, the individual would have
to hire his own lawyers and pay judgments out of pocket.
For these reasons, wise business owners buy insurance. They should insure
the business's buildings, property, and liability risks. The personal liability
shield is no substitute for insurance protection.