When it comes to risk management, small businesses and individuals with limited resources are at a disadvantage—a challenge exacerbated by today’s economic uncertainty. Yet, with the right steps, they can put themselves in a strong position to manage potential adversity. One critical place to start is your contracts—one’s ability to uphold and enforce them is at the heart of managing risk.
Take the recent headline-grabbing legal victory for actor Larry Hagman, the unforgettable J.R in the classic series “Dallas.” Hagman, a busy man, had opened an account with Smith Barney, entrusting his financial adviser to prudently manage his considerable nest egg: 75 percent fixed income, 25 percent equities. Instead, his broker did the opposite, putting 75 percent of his account into high-risk equities. When the financial crisis hit, you can guess the results.
Hagman took on Smith Barney—and parent Citigroup—and after years of battling in court, he won and recovered more than $400,000 in legal fees from his adversary, Citigroup. But how can less wealthy and famous small businesses and individuals do the same when justice is on their side?
Know your risks
While it may seem basic, many small businesses and individuals enter contracts without understanding all potential risks. Or worse, they assume they’re exempt from certain liabilities. One area in which business people often overlook the liabilities is employment contracts. For example, famed chef Mario Batali was recently sued by staffers at several of his restaurants for pooling workers’ tips—a potential violation of labor laws. Irrespective of the final verdict, the point remains that Batali, like so many businessmen, didn’t fully understand his legal obligations, thus leaving him exposed to a significant liability.
A good place to start in risk control is consulting your attorney. You should always request a full assessment of your risk exposure, but not just the obvious pitfalls such as damages. Instead, you often have to push attorneys to flag potentially high-risk areas.
One of the faster-growing risks in contracts that doesn’t get the attention it deserves is “loser pays” provisions, which have become commonplace in many contracts. As the name suggests, this means you have to pay the other side’s legal fees if you lose a contract dispute.
A quick electronic search of California cases in the last year shows that more than $14 million has been awarded in the form of “loser pays” fees. Average awards are approximately $300,000—serious money for most if not all. And the sting of paying these large amounts comes at the end of a bitter trial or summary judgment—when finances are most depleted.
Complicating matters, in many cases, the legal fees far exceed the damages. Thus, as many courts have noted, attorneys’ fees awarded sometimes become the tail that wags the dog.
Hedge your bets
Because significant unforeseen expenses can mean having to fire an employee, close a store or worse, businesses need to hedge their risk.
Once litigation is anticipated, important preliminary questions need to be posed to your lawyer. Often, the importance of jurisdiction is underestimated. If you’re bringing a suit, is there a choice of where to file the case? Which courts are congested? What’s a reasonable estimation for a time to trial?
To further hedge your risk, today there are insurance policies available to cover attorneys’ fees awarded pursuant to “loser pays” provisions in contracts. You can purchase this contract litigation insurance at various stages throughout the litigation process. It covers an adversary attorney’s fees per the prevailing party provision in the underlying contract in the event of an adverse ruling at trial or a summary judgment.
Winning “loser pays”
While you can never guarantee victory, no matter how strong your claim, you can budget against your liabilities with greater accuracy. And in today’s economy, where cash is king, the businesses that will survive are the ones that can effectively manage cash flow.
For starters, updating prevailing party provisions in contracts to include not only legal fees, but insurance premiums to cover the fees, further reduces one’s financial liability exposure. In addition, the more you can improve your negotiating position, the more you can reduce your risks. When paying an adversary’s fees isn’t an issue, this, of course, puts a party in a better position to achieve a favorable settlement.
It also lets you take an advantage away from the “big guys.” Deep-pocketed companies often assume small businesses or individuals won’t pursue contract suits because the legal fees can be so significant. Yet contract litigation insurance helps level the playing field and lets good cases go forward without fear of financial ruin for the litigant.
Small businesses always have been at the heart of our country’s economic growth, and the better they can manage financial risk, and the more able they are to pursue good cases, the better off we all will be.
Larry Kruger is the COO of Sonoma Risk Insurance Agency (www.sonomarisk.com), a litigation insurance company. You can contact him at lkruger@sonomarisk.com.
