Tag Archives | liability

Third Party Insurance

See Also:
Evaluating and Renewing Employee Health Insurance Plan
How to avoid additional insurance premiums
Insulate Your Company from Rising Health Insurance Costs
How to Select Your Commercial Insurance Broker
Credit Life Insurance

Third Party Insurance Definition

Third party insurance, defined as insurance purchased by an insurer (1st party) to protect the insured (2nd party) against claims made by someone outside this agreement (a 3rd party), is a common way to hedge risk in a business. This insurance can come in 2 forms: liability or as a part of full coverage insurance. Liability covers the damages to only the 3rd party. Full coverage insurance covers the damages for the third party as well as those for the insured.

Third Party Insurance Explanation

Third party insurance is a way to mitigate the cost of damages which occur to an unexpected victim. You can purchase it as coverage on a variety of assets. Or you can purchase it for a single asset, most commonly a motor vehicle, or a series of assets such as an entire business. For the vehicle, this insurance protects the purchaser from damages made to an outside party due to some sort of accident. For a business, this insurance protects any of the businesses assets from damages created by any other part of the business. As with any other insurance, it is purchased in specific amounts, bears a deductible for any claims made, and has a term sheet made which defines requirements and limitations.

You can purchase third party insurance coverage for both tangible and intangible assets. For example, a machine in a manufacturing plant can physically damage a plant visitor, but so can a website which posts improper information that defames the name of another entity. Some third party insurance coverage is recommended for any business venture. And it is usually included in business insurance. Insurance, third party included, is a necessary cost.

Third Party Insurance Example

Leroy is the owner of a small insurance syndicate which provides services to small, local businesses. Leroy, who started at the lowest job in a major insurance firm and worked his way up to becoming a self-made entrepreneur of his own. As a result, he knows a little something about his business. In fact, he reviews the major claims made to his company every day.

His assistant informs Leroy of a claim that just came in. Apparently one of his client companies, a cloth dying plant, has had an accident. This accident has, unfortunately, hurt 2 employees and a visiting client. Leroy knows what to expect with the workers compensation claim made by this business; he has many calculating applications which provide him a range of costs for this claim.

Third Party Insurance Reimbursement

What concerns Leroy, however, is the third party insurance reimbursement he may be facing. The visiting client, known to Leroy as his insurance third party beneficiary, has apparently hired one of the best lawyers in the city. Leroy is not used to this type of claim, due to how unusual they are. Thus, he is concerned. If the court case associated with this claim wins a large settlement, then it could mean trouble for his company. He knows that his company will survive long term, but in the short term this may create issues in the cash cycle of his company.

Leroy does proper research by looking back into the deductible and total coverage associated with the claim which this third party insurance covers. It seems, perhaps, he was a little more worried than he needs to be. The claim only covers a small portion of the potential sum from the lawsuit. Additionally, the company has made small payments and opted for a relatively large deductible should any problems arise. This, to the misfortune of the business owner being sued, prevents Leroy from paying a large sum in settlement. He resolves to do a little more research but can relax for the time being.

Conclusion

Leroy ends his research on a good note. The case is dropped due to an outside factor. Leroy, knowing that his business would have survived either way, resolves to keep higher cash balances for any future problems. This will protect him from any future, unexpected third party insurance claim.

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Sole Proprietorship

Sole Proprietorship Definition

The sole proprietorship definition is a private business owned and operated by one individual. Furthermore, a proprietorship is unincorporated and is not a legal entity separate from its owner. As a result, the owner earns all of the profits and incurs all of the losses from business operations. Therefore, the sole proprietor is legally liable for all of the activities and obligations of the business. For example, if the proprietorship defaults on debt obligations, the owner risks liquidation of personal assets.

Advantages and Disadvantages of a Sole Proprietorship

There are several advantages to the sole proprietorship. Proprietorships are easy to establish, easy to dissolve, and they give the owner a significant amount of operational freedom and flexibility. For tax purposes, the owner simply includes the profits or losses of the proprietorship with his or her individual tax filings.

There are also disadvantages. The owner has unlimited liability for the activities and obligations of the proprietorship. This puts the owner’s personal assets at risk. Also, because of the small scale of a proprietorship, it can be difficult to gain access to substantial capital resources and financing. As a result, this limits the growth potential of the enterprise.


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See Also:
Partnership
General Partnership
Limited Partnership
S Corporation
How to Run an Effective Meeting

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Loan Term

See Also:
Loan Agreement
5 C’s of Credit (5 C’s of Banking)
Self-Liquidating Loans
How important is personal credit in negotiating a commercial loan?
Loan Origination Fee
Term Deposit
What is a Term Sheet?
Preparing a Loan Package

Loan Term Definition

Loan term, defined as the period of time between when a loan is received and when the loan is fully repaid, is an important time in the life of any business. During the loan term, businesses must carefully watch finances as they have taken on a new liability which drains cash.

During the loan term a business experiences increased responsibilities. These include principal payment, interest payment, covenants (lender requirements), credit requirements, a certain risk to assets pledged as collateral for the loan, and more. All of these factors make the loan term a period of time in which a business must maintain professionalism. Though the loan term is explained above many people also casually refer to the covenants, or lender requirements which must be upheld for to avoid the lender revoking the loan, as loan terms.

Loan Term Explanation

Loan terms, explained simply, generally last up to ten years long. Loans shorter than one year are described as “short term” and loans with a life longer than one year are described as “long term”.

During loan terms, certain “covenants” must be upheld. Covenants, in short, are lender requirements which must be met to prevent the loan from revocation. Covenants start as simple as making interest payments and expand to requirements on debt and financial ratios of the business. As a rule of thumb, the more risk a lender experiences the more likely she is to extend loan covenants. Banks, in this manner, have more relaxed loan requirements than mezzanine debt financiers.

Additionally, the loan term becomes a big factor in matters of payment which are related to the loan. Logically, a short term loan in the amount of $1,000,000 will have to be repaid much faster than a 10 year loan amounting to the same sum. For tax purposes, loan terms have the same effect. A business can receive larger tax write-offs for a short term loan, though these write-offs extend to a longer period with a long term loan in the same amount. Though the loan term seems like a simple agreement related to when the loan is repaid, the effects extend into all matters related.

Loan Term Example

Chris is starting a web design firm. Chris, a student of web design and development since childhood, is an expert in his trade. He has, as luck would have it, found a great partner to market what he does best; create and manage usable web designs. Chris and his partner have had success as a startup, posses a growing collection of assets, and see company growth as their next horizon. They believe a loan will allow for this growth.

Evaluate

First, the two evaluate their options for a loan. Knowing that bank loans are usually some of the cheapest and simplest loans, the two young partners decide on using these. This is after they do their proper due diligence.

The two partners evaluate both short term and long term loans. They will begin by pacing their growth, so they decide on a small short-term loan. They realize that this decision should also be run by a tax accountant soon but decide to move forward for the time being.

Calculate

The two convene to calculate the mathematics which effect the loan. They set expectations for the total amount, interest and principal payments, loan term, and future value of the loan. These factors, together, create the loan condition and provide insight into the expectations and limitations of the company.

Loan Term Sheet

They then begin courting bankers. In this process they discuss several key issues related to the loan term sheet: total term, term of covenants, terms by which if covenants are briefly missed the loan can stay in place, common loan terms for their type of loan, and more. They make sure to find a banker that is educated in his trade.

Conclusion

Now, the two consult with their accountant. The accountant provides useful insight into the deeper matters affecting their loan. Overall, their meeting is a valuable and encouraging lesson. This is much more effective than scouring the web for a “loan payoff calculator”.

The partners eventually receive the loan they desired. They did this with the basis of understanding the environment around their loan. They are confident that if they continue to plan their business operations they can avoid costly mistakes and can create a future for themselves. Loan term amortization is not as frightening as it once seemed.

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Intellectual Property Risk

See Also:
Tips on How to Manage your Lawyer
What should General Counsel’s relationship be with a Board
Corporate Veil Definition
Corporate Veil
Ten In-House Secrets for Reducing Your Company’s Legal Costs
Red Herring

So What Is the Problem With Intellectual Property Risk?

What do a small business software company, a privately held manufacturing company, a big box retailer, and a medical device company all have in common? Intellectual property risk.

Intellectual Property

“Intangible” versus “tangible” assets include intellectual property, which covers a diverse range of legally-protected rights such as patents, copyrights, trademarks, trade secrets, and designs, and other forms of intangibles such as human capital, contract rights and goodwill. In our increasingly knowledge-based economy, intangible assets have economic and strategic importance just like tangible assets such as real estate and product inventory. In fact, there is a silent war between “intangible” assets and “tangible” assets. Many would say that intangible assets are winning.


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Intellectual Property Risk

From the traditional risk management perspective, categorize intellectual property risk as both a first and third party risk.

From the first party intellectual property ownership perspective, the risks include the following:

  • The legal costs of protecting and enforcing intellectual property rights
  • The loss or diminished value of intellectual property as an asset, or diminished licensing or product revenues, as a result of legal findings of invalidity, unenforceability, or non-infringement, or challenges to title or ownership

From the third party intellectual property infringement liability perspective, the risks include:

  • The legal costs to defend against an intellectual property infringement or theft suit;
  • Any resulting settlement or damages costs;
  • Design-around costs; harm to customer relationships; and negative impact on company share price.

Example of Pharmaceutical Companies

To illustrate several of these intellectual property risks, let’s look at the example of a generic pharmaceutical company challenging a name brand pharmaceutical company’s patent-protected drug through a paragraph IV ANDA and a lawsuit against the name brand pharmaceutical company’s patent on that drug.

The risk to the name brand pharma company is that the generic drug company will be successful in invalidating its patent by proving that the US Patent and Trademark Office should not have issued the patent to the name brand drug company in the first place. If this happens, then the name brand pharma company can keep selling its drug. But it can’t prevent the generic drug company from selling a drug based on the same compound at a much lower price. And, the patent asset’s value goes to zero.

The risk to the generic drug company is if it cannot prove that either the name brand drug company’s patent is invalid or that its drug does not infringe on the name brand drug company’s patent. If found to infringe, then the generic drug company must pay damages for any past sales of its infringing product. It must pull its infringing drug off the market or develop another, non-infringing compound on which to base the drug. Oh yes, and both sides will incur several million dollars in litigation costs in this process.

Minimize Intellectual Property Risk

There’s no quick fix, but the disciplined, integrated use of sound risk management practices will minimize intellectual property risk. This requires a coordinated approach by risk management, legal, financial, product development, and marketing to identify the risk, analyze it, and manage it. Who within a company should be responsible for managing intellectual property risk–Legal? Risk management? Product development? Marketing? Finance? Accounting? All of the above.

Is Insurance the Answer?

Insurance is not the only intellectual property risk management strategy. But it can be a key intellectual property risk management tool. The intellectual property insurance market is continuing to mature, despite some stops and starts. The global intellectual property market is on the increase, with some national patent offices creating and supporting intellectual property enforcement programs for their nationals. As underwriting processes and methodologies and policy forms are improved and actuarial data becomes more widely available, intellectual property insurance is expected to grow into a large, mainstream line of coverage, much like what has happened with D&O, E&O and product liability coverage.

Lloyd’s of London

Generally speaking, types of specialty line, stand-alone intellectual property insurance include: infringement liability; enforcement or abatement costs; reps and warranties, and first party loss or impaired value. Lloyd’s of London has been underwriting intellectual property risk for non-North American companies since the early 1980s. Some of its member syndicates are the most experienced global risk insurers.

After a five year hiatus, Lloyd’s of London, along with other London and US capacity, is back to providing intellectual property infringement liability coverage and intellectual property reps and warranties coverage to North American companies. These carriers offer claims made indemnity policies of up to $15+ million in limits for competitively priced premiums. There are also some US domestic alternatives, both stand-alone and as part of other types of coverage such as media, tech E&O, and cyber.

Infringement Liability Policies

Focusing specifically on infringement liability policies, the scope of coverage varies. For example, some markets require that the applicant obtain a freedom to operate opinion from an attorney. Then build the cover around the terms of the opinion. Others undertake their own due diligence and provide full coverage for products, processes or services sold or used by the applicant. More recent policies cover indemnities given to suppliers and licensees. This a very valuable extension for the technology community. Arrange territorial coverage worldwide. Policy terms are typically one year.

Such policies may or may not be duty to defend policies but most will include hammer clauses. Because insurers recognize that intellectual property litigation, particularly patent litigation, requires special training and experience, policy holders are frequently allowed to use their own intellectual property counsel in the event of a claim. However, most intellectual property infringement liability policies have a self-insured retention or deductible that must first be satisfied. In addition, a co-insurance percentage, which insurers may increase if an insured uses its own counsel, does not satisfy the insurer’s criteria or is not on the insurer’s list of approved counsel. The self-insured retention can vary from zero to several million dollars.

Submission and Underwriting Process for Intellectual Property

The submission and underwriting process varies depending on the type of coverage and the carrier. Some carriers use a staged process that provides a non-binding indication of terms to give potential insureds an idea of the limit of indemnity, self-insured retention, and co-insurance that would be offered and the estimated premium. If the potential insured goes forward with applying for coverage, then pay a nonrefundable underwriting risk review fee to the insurer before the insurer will accept the insurance application or perform its risk review. Other carriers require applicants to obtain a legal opinion and the carrier underwrites behind the legal opinion.

How Can Insurance Help?

Use intellectual property insurance for balance sheet protection, contractual liability protection and deal facilitation. For example, a software company with less than $2 million in annual revenue purchased intellectual property infringement liability coverage. But it also covers its larger licensees/customers. The annual premium was only $35,000.

As another example, a company was seeking to close a $60 million sale of a medical device product range to a large medical device company. A term of the agreement was originally drafted so that a $15 million retention (by way of escrow) was to be maintained for intellectual property infringement claims. This was proving to be a deal breaker until the transaction was saved by placing an insurance wrap for the intellectual property reps and warranties in isolation on a multiyear basis.

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Limited Liability Limited Partnership (LLLP)

Limited Liability Limited Partnership (LLLP) Definition

A Limited Liability Limited Partnership or LLLP is a form of business that contains a group of general and limited partners. Generally, the general partners have a managerial interest in running the business; whereas the limited partners have solely a financial interest, or what they invested in the company. The difference between an LP and an LLLP is that the LLLP general partners receive limited liability under the law.

Limited Liability Limited Partnership (LLLP) Explained

The Limited Liability Limited Partnership agreement is not a widely used business form because it is new to the business environment. Many LLPs are not even aware the reduced liability that they can see for their general partners under the LLLP form. Some states do not allow the LLLP as an election yet. As a result, states have not established uniformity. Therefore, it makes it hard to make this election if the company works across several states. There are only a few industries that have adopted this form, like real estate companies and some television broadcasters like CNN.

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See Also:
Limited Liability Company (LLC)
Limited Partnership
General Partnership
S Corporation

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Interest Expense Formula

Interest Expense Formula

Interest expense calculations involve 4 parts: Principal, Rate, Time, and Compounding.

Use the following formula to calculate simple interest expense (which excludes compounding):

Interest Expense = Principal X Rate X Time

To calculate the compound interest rate, use the following formula:

Principal X (1+ (R / N))(N X T)

Where:
R = Interest rate
N = Number of times interest is compounded in a year
T = Time in years

Interest Expense Calculation Principal = $50,000 Interest Rate = 7% Time = 3 years

$50,000 X .07 X 3 = $10,500 in interest expense

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Interest Expense Journal Entry

When recording an interest expense journal entry, the interest expense account is debited and the cash account or the interest payable account is credited. This represents money coming out of the cash or interest payable account and going into the interest expense account.

If you have already recorded the interest payment as a liability, then it may show up on the balance sheet as interest payable. If it has not already been recorded as a liability on the balance sheet, then the amount used to pay for the interest expense will come out of the cash account or the prepaid interest account on the balance sheet. Make this journal entry when the interest expense is recognized.

Journal Entry Example

Depending on the circumstances, the journal entry may look like one of the following:

                                 Debit                Credit

Interest Expense                  $1,000
Cash                                          $1,000

Interest Expense                  $1,000
Interest Payable                              $1,000

Interest Expense                  $1,000
Prepaid Interest                              $1,000

Interest Expense Example

Dwayne has started a company which rents party equipment. The equipment in which he rents are too expensive to buy straight up. Dwayne is considering financing some equipment, mainly the additional trucks he needs to move supplies, so that he could provide a high level of service. Dwayne wonders what his interest expenses would be. He looks on the web to find an “interest expense calculator”. Dwayne calculates these results:

Principal: $50,000 Interest: 7% Time: 3 years Compounding: None

So:

$50,000 X .07 X 3 = $10,500 in interest expense

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General Partnership

See Also:
Sole Proprietorship
Partnership
Limited Partnership
S Corporation
Tips on How to Manage your Lawyer

General Partnership

A general partnership, defined as a private business owned by two or more general partners, is one of the most common legal entities which do business. Furthermore, it is unincorporated.

General Partnership Explanation

A general partnership, explained as a legal entity which is not separate from its owners, binds two partners together in a business. The details of the partnership, such as profit and loss sharing and decision-making rights, are stipulated in a contract. That contract is called a partnership agreement.

General Partnership Liability

In a general partnership, every partner has unlimited liability for the obligations of the business, including debts and taxes. This means if the partnership defaults on loan payments, then the personal assets of the general partners may be liquidated to repay the debt. This best exemplifies general partnership liability risks, though others do exist. General partnership liability insurance is available to protect partners from each other. The benefit of this is that it protects the personal assets of the partner not at fault. Due to the fact that this is one of the greatest risks of a general partnership, or sole proprietorship for that manner, this type of insurance is recommended.

General Partnership Agreement

In any type of partnership – a general partnership, a private limited partnership, or a public limited partnership – a general partner is an individual who is responsible for the operations of the partnership and has unlimited liability for the obligations of the business. This is probably the most important aspect of the general partnership agreement definition as it explains the worst-case scenario associated. Different states have different specifics for this type of business entity. A general partnership agreement in California, Texas, and other states each have their own nuances. It is important to consult a lawyer when considering how this may effect the business on a national and state level. General partnership agreement samples are available online which may be a useful read prior to meeting with legal counsel.

General Partnership vs. Limited Partnership

In a general partnership, all of the co-owners are general partners with unlimited liability for the obligations of the business. In a limited partnership, there is at least one general partner and at least one limited partner. A limited partner is an investor whose liability is limited by the amount of capital invested by that individual. General partnerships are always owned privately. In comparison, limited partnerships can be privately or publicly owned. These and several other, more specific differences define general partnership advantages and disadvantages. A partner with less vested interest would likely prefer to be a limited rather than general partner.

Example

Colin wants to start an HVAC (heating, ventilating, and air conditioning) company with his partner Jed. Colin and Jed, experienced in the operations of their business, have a lot to learn about the professional world. The two settle on a partnership, then they start. They assemble marketing materials, purchase equipment, and take other actions to get their business off the ground. The two feel they are making some progress.

Then they decide to meet with a lawyer to finalize the company. The lawyer, skilled at his trade, makes a discovery. Both partners do not expect to invest or work equal amounts of time. Colin can remain fully dedicated while Jed, having a family and children, can not miss a months pay in the process of establishing the company. He must keep his 9 – 5 job until the company creates revenue. The lawyer uses this as grounds to convince the two to use a limited partnership rather than general. The two partners leave the meeting with a new perspective. With their mind changed, they decide to learn much more about the business of HVAC. Their new found drive will surely pay off in the long run.

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