Starting a business is an ambitious undertaking, and new entrepreneurs may encounter legal landmines that put their hard work at risk. In order to better understand these common legal issues, a small business owner should ask themselves this series of questions.
(1) What are legal landmines?
Simply put, legal landmines are liabilities. Civil liabilities are legal obligations that may require a party to pay a monetary penalty to the government or compensatory damages following a private lawsuit. Criminal liabilities exist to hold a party responsible for breaking the law that may require payment of monetary penalties or, in extreme cases, serving jailtime.
(2) What kind of entity is my business?
An important way for a small business owner to avoid these landmines is to understand different types of business entities and figure out which structure best suits their needs. The most common entities are Sole Proprietorships, Corporations (C-Corps and S-Corps), and Limited Liability Corporations (LLC). A Sole Proprietorship is not a separate entity from its owner. Consequently, a small business owner with a Sole Proprietorship can be held personally liable for any business reason. On the other hand, a corporation is a legal entity that is separate and distinct from its owner. This means that there is limited personal liability for directors, officers, and shareholders and the business can sue, be sued, and contract separate from those parties. In a C-Corporation, more corporate formalities must be observed than with other entity types. In an S-Corporation, there are similar corporate formalities; however, there are also additional limits on structure, classes of stock that are impermissible, and a different form of taxation known as pass through taxation. Finally, in a Limited Liability Corporation there are limits to personal liability for owners, fewer procedural formalities, greater flexibility with profit flexibility, and the use of pass through taxation.
(3) Do I have employees or independent contractors?
The distinction between employees and independent contractors is crucial. Having employees instead of independent contractors impacts the kind of insurance coverage you need, your liability for their actions, if you must withhold taxes, and if you are responsible for providing benefits. Figuring out if you have employees or independent contractors depends on several factors which focus on the control over the person. Some things to consider: (i) Does the other person have discretion in the manner in which they perform their work? (hours, times, dates, etc.) (ii) Does the other person have an independent business? (iii) Is specific work being done for a fixed price or for a lump sum (not hourly)? (iv) Is the other person not subject to discharge because they adopt one method of doing work over another? (v) Is the other person not regularly in your employ? (vi) Does the other party have the risk for profit or loss based on the work they are doing for you? (vii) How permanent is your relationship? (viii) How integral are the other person’s services to your business?
(4) What kind of insurance do I need?
Workers Compensation Insurance: Workers’ Compensation Insurance protects against claims from employees for occupational disease and injuries from accidents. State law requires an employer to have workers compensation coverage when it has “three or more employees…regularly employed in the same business or establishment.”
General Liability Insurance: General Liability Insurance should cover your vicarious liability for an employee’s negligence. However, the employer or business may be liable for the negligent acts if the acts were expressly authorized, committed within the scope of employment and in furtherance of your business. Generally, your business won’t be liable for the intentional actions of your agents or employees except for negligent hiring, supervising and control. This liability arises if you knew or should have known of the employee’s unfitness or bad habits and the resulting harm should have therefore been foreseeable. To avoid this issue, thoroughly screen employees and maintain files on both employees and applicants.
Automobile Insurance: You may want additional automobile insurance if your employees are driving as part of their job because personal auto insurance policies usually include exclusions where the vehicle is engaged in “commercial activities.”
(5) Am I in compliance with state laws?
North Carolina is an “Employment at Will” state, meaning that an employer can terminate an employee for any reason unless the employee contract provides otherwise, or termination would be in violation of federal or state law or public policy. Despite the flexibility that Employment at Will states provide business owners, there are still several other laws that employers should know to protect themselves from legal liabilities. First, the Wage and Hour Act dictates that an employer must any and all wages not in dispute and notify employees of policy changes. Second, the Equal Employment Practices Act deems that any business with 15 or more employees may not discrimination against any person on the basis of race, religion, color, national origin, age, sex, or handicap. Third, the Retaliatory Employment Discrimination Act ensures that any employee who does or threatens in good faith to file a workers’ compensation claim, whistleblower claim, or wage and hour act claim may not be retaliated against for those reasons.
(6) Am in in compliance with federal laws?
Federal employment laws are overseen by the Equal Employment Opportunity Commission (EEOC), and applicability depends on the number of employees a business has. For example: a business with 1 or more employees must comply with the Fair Labor Standards Act, Equal Pay Act, and OSHA; a business with 15 or more employees must also comply with the Americans with Disabilities Act and Title VII of the Civil Rights Act of 1964; a business with 20 or more employees must comply with the Age Discrimination Act; and a business with 50 or more must comply with the ACA. While this list is not exhaustive, it provides a basic overview of important federal laws that small business owners should know.
(7) What immediate steps can I take to protect myself against legal landmines?
First, document and keep good records on number of employees, payroll, tax records, days and hours worked, disciplinary actions, and termination reasons. Second, maintain an employee manual that lists all policies and practices of the business. It is crucial that you follow your own policies because they are only useful if applied consistently and fairly. Finally, if a claim is filed against you—don’t panic, just make sure to respond within the timeframe listed with as much documentation as possible.