What I’m about to share with you is going to get me a ton of email telling me that I’ve finally stepped over the line. That I’ve lost my mind. That I’m just plain nuts. That’s okay — I’m going to share it anyway. Here is a great tip: Just say NO to E&O!
But before you fire up your computer and email to tell me how crazy I am, let me explain. I’m very much in favor of risk management… just not by using E&O insurance. There are two much better ways to limit your risk that are both cheaper and do a better job.
First, practice real estate as a corporation as I mentioned earlier in this series. I have a corporation (corporation 1) that owns my real estate firm. It has a very low net worth. In fact, it keeps no money in the bank, and it doesn’t own any assets. The only asset it owns is its real estate license.
I have another corporation (corporation 2) that is our holding company. That company owns the furniture, fixtures, equipment, computers, brand, etc. and leases and/or licenses them to the corporation 1. That keeps the assets in corporation 2 and the liabilities in corporation 1. But corporation 1 is the entity dealing with the public.
The idea is that the corporation that practices real estate has no net worth, so there is very little risk, should it ever be sued. It’s what some people refer to as being “judgment proof”, referring to the fact that there is no “pot of gold” to go after in a lawsuit, should they manage to win a judgment. If there are no assets to go after, a potential civil judgment doesn’t really matter that much.
Not only does it limit your risk, but it also works as a built-in lawsuit deterrent. Let’s face it, when the plaintiff’s lawyer finds out there are no assets, they will have little motivation to file a lawsuit. Of course, any good attorney will surely attempt to pierce the corporate veil so your record keeping better be good. What is piercing the corporate veil?
Usually a corporation is treated as a separate legal person, which is solely responsible for its own actions and liabilities (in this case, the practice of real estate). Common law countries usually uphold this principle of separate personhood, but in exceptional situations may “pierce” or “lift” the corporate veil. Piercing the corporate veil describes the legal decision to treat the liabilities of a corporation as the liabilities of its shareholders or directors.
That’s why if there is not a clear-cut distinction between you, the broker, and the corporation, it is possible that a court would say that the corporation is just a “sham”, or a “alter-ego” and would look beyond the “legal fiction” to the reality of the situation: you the broker hiding behind the corporation.
In other words, the company has to be real and not just a sham. That means you have to go through the steps of keeping it legitimate and not just an alter-ego. Specifically, that means keeping corporate records, separate bank accounts, and actually treating the corporation as a separate legal entity. But if you do that, you will be protected from the liabilities of the corporation.
The second thing you should do is purchase an umbrella liability insurance policy. Often you can buy it from your homeowners insurance provider. A policy for a million dollars can generally be purchased for $200-$300 per year. That policy will not only cover you against any claims against you personally, but it will extend the existing protection on both your vehicle and homeowners insurance coverages.
What is umbrella liability insurance? An umbrella policy is to E&O coverage what life insurance is to credit life insurance. In other words an umbrella liability policy is a lot cheaper and it covers more than an E&O policy. More importantly, E&O companies have a long tradition of not paying legitimate claims by hiding behind technicalities. So, when you consider their claim payment history and their high price of coverage, you have a great reason to just say NO to E&O!
Let me give you one personal example. When I was a new agent and had begun to grow a team, our company had E&O insurance. One of my team members was out showing houses to her clients in her brand new Land Rover. On the way to view a home, while driving on a country road at highway speed, someone pulled in front of her. She slammed on the brakes and swerved, ultimately rolling her SUV.
Everyone in the vehicle was injured. We assumed that all would be fine since, after all, we had E&O. As it turned out, E&O would not pay for the agent’s liability. Neither would her automobile liability policy, since the wreck occurred while she was using her vehicle for business. Thankfully, she had an umbrella liability policy, and it did paid the claim. Lesson learned.
But I’ll go one step further. As I speak and train agents across this country, I am often asked about E&O, and I always have the same response. I ask them if they have ever had first-hand experience where E&O actually paid a claim. Not that they heard about it from a friend, but that they, personally, were involved in a situation where E&O paid out. Not a single one of those thousands of agents has ever had a first-hand experience of E&O paying a claim.
So I’ll make you the same challenge: If you’ve had first-hand experience where E&O actually paid off, then post a comment to that effect. If they didn’t, post that too. I’m betting there won’t be many, if any, that collected. So, I say just say NO to E&O! And that’s Max-Bang!