Regardless of how careful we are, conflicts arise in business. Conflicts among owners, among employees, and with vendors and customers are common. Generally speaking, we try to resolve these conflicts quickly with minimal risk and cost but sometimes they spiral out of control. As a business owner, it’s essential that you know what tools are available to you to insulate your risk from these disputes and help you to negotiate a settlement or agreement so you can move your business forward. A company has three key tools to address and mitigate risk: contracts, insurance, and the business structure. I see them as cascading from narrow to broad in coverage as follows:
- Contracts. A contract is the narrowest. It outlines the terms and conditions of a business relationship including the goods and services to be provided, the payment terms, termination provisions, and dispute resolution procedures. The objective of the contract is to insulate a particular business relationship from other aspects of the business. If the relationship falters, the contract provides the ground rules such as limitations on liability, indemnity, and dispute resolution procedures for dealing with issues. Although litigation and arbitration are expensive, they provide a baseline framework for conflict resolution between parties. Each relationship is unique and the right terms for your protection should change to reflect the specifics of that relationship.
- Insurance. Insurance provides the next tier of protection when a contract does not exist or the contract doesn’t address the issue at hand. An example might be a premises lease. If damage occurs that is clearly the business’ responsibility under the lease, it’s not covered by the terms of the lease, so the business will leverage its insurance to cover the costs. Similarly, a company may have an employment agreement with its employee but the employee’s claim against the company for a workplace injury or harassment would not be covered under that agreement. Insurance would be a way to mitigate this risk and address the claims. In business planning, you should understand what insurance is available to your business and what policies you need in place to mitigate the risks that may not be covered by a contract.
- Business Structure. An LLC or corporation provides liability protection for the owners of the business. If the business has a costly claim or damage that it cannot pay and it does not have insurance coverage, the business can choose to shut its doors. The owners of the business will not be held liable for the debts of the company unless the owners have 1) proactively accepted personal responsibility under a personal guarantee; 2) personal responsibility under the law (i.e. for unpaid taxes and wages); or 3) failed to maintain separation between the company and the individuals. The failure to respect the “corporate formalities” of the business by separating personal and business matters and by maintaining corporate minutes and other governance requirements can create personal liability for the owners where a creditor may “pierce the corporate veil”. In general, however, where a business is being treated as a separate structure and the business owners are acting responsibly as fiduciaries of the business, the entity will provide the desired protection from liability.
When planning for your business’ growth or any new business relationship, think about what could go wrong in the relationship and which of these tools will be most effective in offering the protection you need to mitigate the risks.