Should business owners be concerned about lawsuit risk?

Risk management is potentially of great importance to business operators and yet poorly understood by most. It is possible to lose your business and most major assets to one legal liability judgment.
Much of the exposures businesses face are not intuitive. To manage risk, one needs to understand risk in its many forms. For example, legal Structure, employment law, product liability, contract risk, partnership and succession risk, insurance claim denial risk to name a few. It is beyond the scope of this writing to delve deeply into any of the specific risk exposures that a business owner faces daily, it is the intent, however, to raise the awareness of owners and managers to allocate thought, time and resources to becoming savvy to risk exposures, taking proactive steps to mitigate risk, and control losses. Naturally, all business risk cannot be eliminated in the competitive commercial environment and information age in which we all function.

What is asset insulation planning?

Asset protection planning may be described as the purposeful process of organizing one's assets ownership and affairs in advance so as to insulate them from loss by reason of potential future fiscal calamity. The aim of asset insulation planning is to become unattractive to litigate by removing the financial gain (as much as is practical) that drive most plaintiff’s lawsuits and their counsels. Businesses are a favorite target of litigators as many seek to settle cases (even weak merited ones) rather than defend and risk negative publicity, large legal costs and loss of valuable time in litigation than can span years. Over 50 percent of all civil lawsuits target small businesses annually of which 75 percent are thought to be frivolous. 90 percent of business owner defendants settle frivolous lawsuits simply to avoid higher court costs and embarrassment. This pattern of behavior, unfortunately, fosters, even more, law suits.

How large a problem is business litigation?

Disturbing data:
Each year some 200 billion dollars is involuntarily redistributed to claimants by US Courts.

There are 15 million civil lawsuits filed annually in the US costing litigants $251 billion in legal fees and associated costs. The US by far exceeds every nation on the planet in litigation cases and costs.

80% of the world’s lawyers reside in the US. (1,316,000 lawyers) Many nations utilize the “English Rule” of loser pays costs and expenses of the winner. This is designed to discourage frivolous litigation. The US does not do so. Many nations disallow contingency based legal representation, US does not. This practice while allowing the poorest of plaintiffs to file a complaint also enables frivolous suits as the plaintiff has little to lose. Seasoned quality attorneys will predictably eschew low merited contingency compensated cases.
NERA Economic Consulting (NERA, a global firm of experts) performed a study of litigation impact on small business. Their findings are as follows: The tort liability price tag for small businesses in America in 2008 was $105.4 billion. Small businesses bore 81% of business tort liability costs but took in only 22% of revenue. Small businesses paid $35.6 billion of their tort costs out of pocket as opposed to through insurance.

In a 2007 Harris poll of business owners/managers that indicated they were concerned about frivolous or unfair lawsuits, 62% said they make business decisions to avoid lawsuits. These decisions had the following effects:

61% said they made their products and services more expensive.

45% said they made a product or service unavailable to customers.

23% said the business decisions forced them to cut employee benefits.

11% said the decisions forced them to lay off employees.

More than a third of these business people respondents (34%) had a lawsuit filed against them in the prior ten years. These suits had the following effects:

73% said business suffered because litigation was very time-consuming.

4% said business suffered because litigation was very expensive.

61% said they felt more constrained in making business decisions generally.

45% said they changed business practices in ways that do not benefit their customer.

Why are small business owners generally poorly versed in these critical matters?

In most small businesses (closely held), management wears many hats primarily for cost containment.
There are usually no departments for human resource (HR), general counsel (In-house legal), risk management (insurance related) or external board members. Accounting and tax compliance services are often provided by a local external CPA firm as needed. Legal services are also often provided by a local general practice attorney on a reactive basis as issues arise. Risk transfer (insurance) products are generally sold by local external commissioned sales people that may have little expertise in business risk management beyond the policies they sell. There is rarely coordinated planning where each of the external providers work collaboratively to further the best interest of the business owner. Many of the external providers do not even know one another. While there are plenty of high-quality business consulting firms both national and regional, their fee structure and marketing focus generally bypasses small businesses.

Employee suits

Hiscox (US based global insurer) 2015 study using data from EEOC and state counterparts as well as its own claims experience of employment practices suits found the following:

A representative study of 446 closed claims reported by small- to medium-sized enterprises (SMEs)
showed that 19% of employment charges resulted in defense and settlement costs average of $125,000. On average, those matters took 275 days to resolve. Most employment matters don’t go to trial, but for those that do, the damages can be substantial. The median judgment is approximately $200,000, which is in addition to the cost of defense. About 25% of cases result in a judgment of $500,000 or more.

Sue for what?

Retaliation, unlawful pre-employment questions, wrongful termination, harassment, defamation, discrimination, dishonest evaluation, invasion of privacy, deprivation of career opportunity, wage, unsafe working conditions

Other business suits:
Intellectual property (IP), breach of contract, electronically stored information (ESI), employee fraud, product liability.

Isn’t commercial insurance enough to protect me?

The short answer is no. Commercial liability insurance coverage is the basic foundation of risk management for those perils that are insurable. Many of life’s most serious risks are not insurable or have exclusion and limitations. e.g. Co-owner disputes, divorce, punitive damage awards, wage-related employment practices, environmental risks to name a few. All policies have internal limitations on perils that are covered. Judgments may exceed policy limits, especially in class action suits. (Filed by a class of plaintiffs)

Best practices for closely held business owners to consider

Owner/ operators should become savvy to legal liability risks at least on a cursory basis. Generally, business owners can be held liable for the products/services they sell, staff they employ, contracts they are a party to whether they are directly involved in an event or not. Even when they are not aware of what an employee may be doing, there is liability potential. Owners should thoughtfully examine all aspects of risks as they relate to what the particular enterprise is doing. What could go wrong? How severe an impact could this have on the business? What changes can I make to mitigate risk and control damages? Do my employees understand risk and our vulnerability to claims? Are my business practices ethical and defensible if challenged? Once the owners have gone through this analysis internally, it is wise to bring in outside risk management specialists to advise as to what changes can be made to insulate the business and major assets of the owners based on the recognized exposures surfaced. There are substantial liability differences based on which business entity for is utilized. i.e. LLC, Corp, LLP, LP, Partnerships. Good planning often separates business activities and assets into distinct entities rather than one. An insurance coverage specialist (non-commission sales) can be engaged to issue a written report as to the efficacy of the in-place coverages and any overlap or insurable areas not addressed. An employment practices specialist can be engaged to review the employee handbook, hiring and termination practices as well as the employment practices insurance policy (EPLI).

Summary
Owner awareness and the utilization of seasoned specialists to insulate what may be the owner’s single largest asset is a necessity if one is to properly protect the business. The cost of a single defense against a claim will likely exceed the cost of proper planning not to mention aggravation and time lost after the fact even if you win.

Ray Chodos is the managing member of the Wealth Preservation Group LLC™
in Greenwich CT.

Should business owners be concerned about lawsuit risk?

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