Liability Insurance Protects You From Yourself
Liability insurance should be the last line of defense for a small business owner who is implementing a comprehensive asset protection plan. Liability insurance covers damages (both personal injury and property damage) you, your employees, or your agents cause. Liability policies can be general or can cover specialized types of misconduct, such as malpractice.
Liability insurance covers damages that you (or your employees) cause to other persons, both personal injuries and property damage. Thus, a liability insurance policy will have separate provisions, including separate limits, for personal injury and property damage caused to other persons.
Comprehensive general liability insurance is designed to provide broad coverage for liability to other persons. Generally, it covers all liability for personal injuries or property damage caused to other persons, unless specifically excluded. Thus, in a comprehensive general liability insurance policy, it is very important to read and understand all of the exclusions, and compare your options, before purchasing the policy.
Property Insurance Distinguished. A single policy may provide for comprehensive general liability coverage (for damages caused to other persons in the form of personal injuries and property loss) and separate coverage for damage to property owned by the insured.
However, comprehensive general liability coverage alone does not offer protection for damage to property owned by the insured.
Property insurance must be included in the policy for the insured's property to be covered.
Specialized liability policies. While every business should consider a general liability policy, certain types of businesses may benefit from specialized policies. Specific forms of liability insurance (or endorsements) are necessary to cover exclusions from a standard comprehensive general liability policy.
Also, a small business owner may be compelled to purchase certain specialized liability insurance in some cases (e.g., errors and omissions liability insurance), depending on the particular circumstances. To make the wisest choices when purchasing insurance, you should become familiar with coverage issues involved in a comprehensive general liability insurance policy, as well as with specialized liability policies.
Be Aware of Common Elements and Exclusions in Liability Insurance
Before deciding on the type of comprehensive general liability insurance for a small business, an owner needs to understand some basic information on what these policies cover.
Endorsements expand coverage protection. Specialized forms of liability insurance are more restricted in scope and are, in fact, specifically designed to cover situations excluded in a comprehensive general liability insurance policy. Sometimes, rather than purchase a separate specialized policy, an insured may be able to pay an additional premium for an "endorsement"--an amendment to a comprehensive general liability insurance policy that will cover a standard exclusion.
When are occurrences covered? A comprehensive general liability policy generally will cover liability for any "occurrence" during the policy period--that is, the policy will cover liability for personal injuries or property damage that the insured caused to another party while the policy was in effect. A lapse in insurance coverage opens a window of vulnerability. Some policies are "claims made" policy, which are usually cheaper because they will only cover claims made while the policy is in effect.
Expected damages aren't covered. Damages that were subjectively "expected or intended" by the insured will be excluded from coverage. Courts have ruled that to deny a claim, it is not sufficient for the insurance company to prove that a "reasonable person" would have expected the outcome (i.e., what the law terms "objective intent" is not sufficient). Rather, the insurance company must prove what the insured party was actually thinking at the time, which is a more difficult burden to meet.
Damages Tied to Intellectual Property, Advertising Can Be Covered
Coverage for personal injuries to another person traditionally has been included in a comprehensive general liability policy. These injuries can result from:
- invasion of privacy,
- copyright, patent, trade name and trademark infringement, and
- unfair business practices.
This type of liability can arise from advertising, publications on web sites, or general business practices.
Recently, insurance companies have begun excluding copyright, patent, trade name and trademark infringement (intellectual property rights) claims from coverage. They have also begun defining "advertising" more narrowly for purposes of denying coverage for libel, slander and infringement of intellectual property rights.
If coverage of your proposed policy is too narrowly drawn or the exclusions too significant, you should consider requesting a policy endorsement that will broaden or purchasing a specialized "cyberspace" insurance policy, especially if the company maintains a large presence on the Internet.
Investigate Need for Coverage of Data as Property
Outside of the area of intellectual property, coverage for damages to another person's property only may apply if the property is "tangible," or the damage "physical." Issues arise here as to whether computer data is "tangible," or capable of "physical" harm. Thus, a company that provides computer hardware, software, or programming services should determine whether the standard policy includes this coverage. If it does not include the desired coverage, the party should request an endorsement that includes this coverage or consider purchasing a separate, specialized liability policy.
Specialized Liability Policies May Be Needed
As you review the risks involved in operating your business, you may find that you need specialized forms of liability insurance that will cover exclusions from a standard comprehensive general liability policy. Or, you may be in a profession that requires that you carry specialized insurance. While anything (even the possibility of alien abduction) can be covered by insurance, this article focuses on the more common types of policies and endorsements:
- errors and omissions liability (or malpractice) policies;
- directors and officers liability policies;
- cyberspace liability insurance policies; and
- environmental pollution
The most common, and likely one of the most essential types of specialized liability insurance--automobile insurance--is covered in Insuring Your Automobile Is Essential.
Errors and Omissions Insurance Critical for Professionals
An errors and omissions, or E&O, liability policy (often called malpractice insurance) covers liability for negligent acts committed by professionals, such as including physicians, accountants, lawyers, and architects.
Malpractice Coverage May Be Mandatory
If you are in a licensed profession, such as law or medicine, an E&O liability policy may be mandatory. Many states require that certain professionals maintain an E&O policy with a certain minimum amount of liability coverage, although the exact requirements vary widely from state to state. State licensing boards and professional organizations in each state are good sources for information on liability insurance requirements imposed on particular professions.
In some states, the requirement may only extend to certain professionals (e.g., physicians). In some cases, the obligation applies to anyone practicing in the profession, regardless of the business form in which they operate. In other cases, the obligation may be imposed only on professional corporations, limited liability partnerships, or limited liability companies. In this case, professionals operating outside of these business forms may not be compelled to obtain liability coverage. Make sure you check your state's particular laws.
Evaluate Your Exposure If Malpractice Coverage Is Optional
Where E&O liability coverage is optional, the professional must weigh the risk of being self-insured against the costs of insurance. In doing so, the professional must remember that the personal commission of a tort, such as malpractice, represents a significant exception to the limited liability that otherwise applies in a limited liability company (LLC) or a corporation.
You are personally liable for malpractice regardless of the business form in which you operate. This represents a significant departure from the limited liability that otherwise exists in the LLC or corporation.
An LLC or corporation offers you protection from personal liability for malpractice committed by other owners and other employees of the business entity, provided of course that arrangements among the owners and with the employees are properly structured.
However, a professional who negligently hires or supervises an employee may be held personally liable if the employee commits an act of malpractice or some other act of negligence on the theory that you failed to reasonably hire or supervise the employee.
To protect against other forms of liability, the professional will have to undertake other asset protection measures described here in this small business guide, including strategically structuring and funding the business entity, exemption planning, the use of asset protection trusts, etc.
Malpractice Insurance Can Cover Negligent Acts
An E&O policy will cover both "negligent" acts and errors and omissions that result in loss to another person. Thus, coverage should extend to all causes of action that arise from the insured's professional services and not merely a cause of action based on negligence. Insurance companies sometimes attempt to limit coverage to a cause of action based on negligence, arguing that only negligent errors and omissions are covered. The courts generally have rejected this argument from insurance companies.
E&O Policies Cover Only Professional Services
An E&O policy will only cover liability arising out of "professional services." Insurance companies sometimes attempt to disclaim coverage on the grounds that the insured's activities did not amount to professional services.
Courts generally have ruled that any ambiguity must be construed in a way that favors coverage. Thus, a definition of professional services will be broadly construed. Courts have ruled that any activity that requires mental or intellectual skill meets the definition of "professional services."
Coverage Options Are Claims-Made Basis or Occurrence
An E&O liability insurance policy will usually be issued as a "claims-made" policy. This is not the standard form of coverage with which most people are familiar. Under this type of policy, coverage instead applies to any claim made during the policy period, rather than coverage applying to any "occurrence" during the policy period.
With a "claims-made policy," coverage will not continue after the policy period has expired. Thus, a claim made after the policy expires is not covered. A "claims-made" policy will not cover claims made for an event that occurred prior to the policy's effective date. In contrast, an "occurrence" policy covers any claim that arises during the effective date of the policy--even if the claim is not made until after the policy expires.
A claims-made policy usually offers less effective coverage and, accordingly, is less expensive for an insurance company to issue. This savings may result, in theory anyway, in lower premiums for the insured party. Nevertheless, because of the superior protection generally offered by an occurrence-based policy, the small business owner should inquire as to whether an occurrence-based policy is available. If such coverage is available and the premium is not cost-prohibitive, the small business owner should consider paying the additional premiums and purchasing the occurrence-based E&O policy.
Corporations, LLCs Should Purchase D&O Insurance
Corporations should purchase directors and officers (D&O) liability insurance. In addition, a limited liability company (LLC) should purchase a specialized policy that applies to "managers" and officers of the LLC. Similarly, a statutory close corporation, which is usually managed by the shareholders rather than by a board of directors, should have a specialized policy that covers the shareholders while acting in their capacity as managers or officers of the entity.
A D&O liability policy usually is a claims-made policy, covering only those claims made during a policy period. A policy that covers any occurrence during the policy period usually is the best type of coverage, but it may only be offered at a higher premium, or not at all. Where an occurrence-based policy is available and it is not cost-prohibitive, the occurrence-based policy usually will be the better choice.
Covered parties should be specifically identified. A D&O liability policy normally covers only those individuals specifically named in the policy. Thus, caution must be exercised to ensure that each director, officer or manager is properly listed, and that new parties are added or deleted when there is a change in the management of the business. The entity itself, its managers, subsidiary entities, and managers of subsidiaries usually can be listed as covered parties under the same policy.
Of course, a separate entity may alternatively decide to take out a separate D&O liability policy. This usually makes sense only when management of the entities is not overlapping or the insurance company requires separate policies. If a single policy is used, it is always wise to review the policy in advance to ensure that each entity and its managers are covered.
Officers, Directors and Managers should be indemnified. The operating agreement for an LLC or statutory close corporation (or bylaws for a conventional corporation) generally should include an indemnification clause that requires the entity to reimburse the managers for any liability they personally incur while carrying out their management duties.
Generally, state laws allow indemnification, except to the extent that the manager's conduct was a willful violation of the law. Business-friendly states, such as Delaware, allow for extremely broad indemnification of owners. The clause will add an extra layer of projection for managers, in addition to the D&O liability policy.
Of course, when an indemnification clause is triggered, the entity itself pays the damages. The D&O liability policy will mean that the loss will not have to be borne by the entity, provided of course, that the entity is a named party on the policy.
Be aware of D&O policy exclusions. D&O policies have very specific provisions relating to coverage. Exclusions in a D&O liability policy can be significant. Therefore, read the proposed policy thoroughly. Common exclusions include:
- bodily or personal injuries
- intentional or criminal violation of laws
- "ultra vires" acts (i.e., acts outside of the scope of the manager's authority) and
- liability assessed by a regulatory agency.
In some highly regulated businesses, managers may face their greatest liability exposure from actions taken by state or federal agencies. If a significant form of exposure to liability is excluded (e.g., liability assessed by a regulatory agency), request that the policy include an endorsement adding coverage.
Clearly, the cost of the endorsement must be weighed against the cost engendered by the risk itself. Finally, D&O liability polices sometimes exclude defense costs from coverage. The duty to defend is important. Therefore, make sure that the policy includes a duty to defend clause.
Cyberspace Liability Insurance Is Increasingly Needed
Cyberspace liability insurance covers Internet and computer-related losses caused to other parties. A cyberspace insurance policy would be especially appropriate for a computer consulting business, an Internet service provider, or a web site developer. It also want to investigate cyberspace liability insurance if you do a regular amount of business or advertising on the Internet.
Shift away from coverage via general liability policy. These losses may be covered in a comprehensive general liability insurance policy. However, many companies have been changing policy language in comprehensive general liability insurance polices to exclude coverage of violations of intellectual property rights, as well as for certain advertising activities.
A careful reading of your general liability policy, your E&O policy and your property insurance policies is needed to see what is covered, where there is overlapping coverage and where there are gaps in coverage. To the extent the company's activities are not covered under one of these policies, a cyberspace insurance policy or an endorsement to your general liability may be needed.
Terms and conditions policy cover a wide variety of actions. A cyberspace liability insurance policy should cover liability for violations of intellectual property rights, invasions of privacy, libel, slander, and property damage, in the form of lost data. In addition to liability coverage, cyberspace insurance also may have a property insurance component, and thus cover damages to computer hardware, software and data owned by the insured.
Finally, an errors & omissions (E&O) component may be available in a cyberspace insurance policy. This insures against liability incurred due to the negligent acts or errors and omissions of the insured's computer professionals who provide services to others.
Environmental Pollution Endorsements Protect You from Hazards
An environmental hazards endorsement on an insurance policy can end up saving the day for a small business owner. For example, today, liability for cleanup and related costs for a polluted site can easily run into the millions of dollars, even in a seemingly small case. Further, liability for these costs can be imposed on an innocent party who currently owns or operates the affected property, even though the pollution was caused by another party many years earlier.
Where liability for environmental pollution is a possibility, check the policy in advance for coverage. A standard policy will usually contain an exclusion for this type of coverage. Consider adding an endorsement to the policy that will cover liability for environmental pollution, if liability is a possibility and the endorsement is not cost-prohibitive.
As mentioned, this type of liability can be imposed on an innocent party. One simple strategy can be used to eliminate this possibility--namely, an environmental inspection. The contract for the purchase of the property would contain a clause mandating that such an inspection be conducted, and conditioning the obligation to purchase on the results of the inspection being favorable to the buyer.
When an endorsement is to be issued that will cover liability for environmental pollution, an environmental inspection may be required by the insurance company, as a condition of writing the endorsement. Note that standard inspections mandated in real estate contracts do not include an environmental inspection. Standard inspections include testing for structural integrity, the proper functioning of mechanical systems, pests (e.g., termites), and environmental hazards (including lead-based paint, asbestos, radon gas, and urea formaldehyde insulation).
These environmental hazards, which are usually included in a standard real estate contract, are potential dangers to the property owner himself. In contrast, an environmental inspection is designed to uncover pollution on the property that may harm surrounding properties and their owners. An environmental inspection would include a review of the property's history, soil and water samples, etc.
An environmental inspection generally must be done by an environmental engineering company and can be very expensive as compared to standard inspections. However, this type of inspection may be mandatory if an endorsement on the policy is requested. In any event, where the possibility of pollution is suggested by the history of the property or by the current owner or operator, the cost of the inspection must be weighed against the potential savings it may produce.
The potential savings could be significant because, generally, liability will not be imposed on an innocent party who obtained a favorable environmental inspection before he purchased the property. Under these circumstances, the cost of the inspection will usually pale in comparison to the potential savings.
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