Being sued can ruin your life, both financially and personally. Unfortunately in our litigious society, the small business owner runs the risk of lawsuits from many directions--injured customers, disgruntled employees, contentious suppliers. Knowing how the legal system works--and the risks inherent in the system--enables you to minimize the damage a lawsuit can cause.
We live in a litigious society and the results of being sued can be both financially and psychologically devastating. In many cases, a defendant who wins a lawsuit still loses financially because the cost of defending against the suit generally will not be reimbursed. In fact, even preparing to defend a lawsuit can be financially devastating.
Litigation can have significant psychological consequences as well. In some cases, those who render professional services may begin to question their competency. Defendants, in general, may be extremely anxious and concerned that they could lose their reputation, their home, bank accounts, and other personal property acquired through years of hard work.
Unfortunately, not all of these concerns are misplaced, Moreover, most people do not know how to manage the legal system which significantly heightens the risk of loss and they further complicate matters by also not having a comprehensive asset protection plan in place.
Significant risk of being sued is not limited to physicians, or even to professionals in general. Any small business owner who will be performing personal services must be especially cognizant of the risks of being sued.
Personal commission of a tort, such as negligence or malpractice, represents a significant exception to the limited liability that otherwise applies in a limited liability company (LLC) or a corporation. Thus, the consequence of personally committing a tort will not only be a risk of loss of the business's assets, but of the owner's personal assets, outside of the business, as well.
In addition, a successful business will employ many other people who may commit negligence while carrying out the entity's business. Liability for negligence committed by employees generally will run to the entity, thus exposing the business's assets to a risk of loss.
If your business sells goods that could cause injury, there is a significant risk that the purchaser, members of that household and, possibly, subsequent transferees will sue the business based on what is termed "product liability."
You also face a significant risk of litigation due to the many contracts you enter into while running your business. If your business and its contracts (including sales and employment contracts) are not properly structured, liability may run you personally. In addition, if you have guaranteed the entity's contracts, liability will extend to your personal assets.
For these reasons and more, it is imperative to have an understanding of the risk factors inherent in litigation, as well as the ways you can better manage these risk factors to your advantage.
The risk of loss from contract and tort liability can be significant for small business owners because the operation of a business naturally involves exposures to liability. However, the civil litigation system itself also creates significant risks because many factors make it more likely that an unjust lawsuit will be filed and, as a consequence, the defendant will be forced to pay significant monetary damages to the plaintiff--either to settle the case or as the result the trial. (On the flip side, a plaintiff with a just but relatively small claim will be forced to forego making the claim for economic reasons that discourage litigation.)
The combination of three components of our civil litigation system presents a real threat to small business owners who one day may find themselves at the receiving end of a lawsuit:
At this point you may be asking yourself what happens if you're the plaintiff in a civil litigation suit? If a small business owner wants to sue a customer who defaulted on an account, or maybe the owner has a claim against another business, chances are the attorney's fee is still going to be paid on an hourly basis. Attorneys typically take cases on contingency only if there is a great likelihood that the damage award will be large enough to justify the services they provide.
So no matter which side you're on, as a small business owner, there's a serious economic downside to being involved in a lawsuit.
Plaintiffs' attorneys often take personal injury and other liability cases on a contingent fee basis, if there is a substantial likelihood of winning a substantial amount of money. In a contingent fee case, the attorneys only get paid if they win the case or if it is settled out of court. If they do win, usually they collect one-third of the amount of damages awarded or paid in the settlement. Some states limit such fees when damages are very large, but they are still in the minority.
A contingent fee arrangement means that a plaintiff can bring or threaten an action without cost free. Generally, the other costs of bringing the action (e.g., sheriff's fees, court fees, and fees for experts) are usually advanced by the attorney and deducted from the plaintiff's share of the damage award. In practice, plaintiff's attorneys usually will not accept a contingent fee arrangement unless there is a substantial likelihood of a win and a large monetary settlement or judgment.
When being sued, you're at a serious economic disadvantage because the plaintiff often has the services of an attorney motivated by the rewards a contingent fee can bring. Unfortunately, you will probably not be able to offer the same economic incentive to your legal team.
Contingent fee arrangements generally are not available to defendants, who usually are not attempting to collect damages. Thus, if you're sued, you must hire an attorney on an hourly fee basis, at rates usually in the range of $150 to $250 per hour. A retainer, or "down payment," typically in the range of $1,000 to $5,000, will be required upfront.
A defendant who does not have significant financial resources will not be able to hire an attorney and, thus, will not be able to effectively defend against the claim. This is in stark contrast to the plaintiff who will bring the claim and enjoy the benefits of a contingent fee arrangement. So before you even get your day in court, economic factors put two strikes against you when preparing for the suit.
The high cost of defending a lawsuit is one compelling reason to carry liability insurance that covers you against the more likely reasons you could be sued. It is essential that your insurance policies have a "duty to defend" clause that you can rely upon to obtain representation if you are sued.
Besides the contingent fee system that ensures a small business owner will be defending a suit with limited resources against an opponent who is not similarly limited, the outcome--win or lose--carries a third financial risk. The legal system does not allow for you to recoup your costs, even if you're right, except in some very limited contractual and statutory situations.
"Loser pays" versus "American system." In a "loser pays" litigation system, the loser of the action is compelled to reimburse the other party for attorney's fees and related costs. This means that, if the plaintiff wins, he is awarded his regular monetary damages, plus his attorney's fees and other costs.
If the defendant wins, he pays no damages to the plaintiff, and he is reimbursed by the plaintiff for his (the defendant's) attorney's fees and costs. Reimbursement does not result in any gain to the defendant. Instead, it just means that the defendant will not suffer any loss.
Many people are surprised to learn that the United States does not have a "loser pays" system. The system used in the United States is known as the American Rule. In the United States, as a general rule, a plaintiff who wins collects only his compensatory damages. He must compensate his attorney at his expense, perhaps from the proceeds of the case. If the defendant wins, he must still pay his own attorney's fees and related costs. Despite the court victory, this is a loss in itself.
The theory behind the American Rule is that a risk of reimbursement might dissuade plaintiffs from bringing legitimate claims, thus causing losses not only to the plaintiffs themselves, but to society as well.
In a contingent fee case, the defendant faces a serious dilemma. He must pay his attorney $150 to $250 per hour (or more), while the plaintiff does not need to pay his attorney anything. A full trial, in a simple case, might cost the defendant $10,000 or more in attorney's fees. Even if the defendant wins the case, he does not get reimbursed for his attorney's fees, and thus loses $10,000.
This system provides a strong incentive for defendants to settle cases by offering to pay plaintiffs' monetary damages, even when defendants are sure they will prevail at trial. If a defendant offers to pay the plaintiff $6,000 to settle the case, the defendant will actually save $4,000, as compared to "winning" the case at trial and paying his own attorney $10,000.
The standard a plaintiff must meet to win a civil case (e.g., a claim based on negligence or breach of contract) is "preponderance of the evidence." This standard is fairly low and easy to meet. This can make the civil litigation system a serious risk factor for small business owners who find themselves defendants in actions, especially in light of other related risk factors (i.e., expert witnesses for hire, pre-trial discovery and right to a jury trial).
Under the preponderance of the evidence standard, the plaintiff must only to establish a more-than-50-percent probability that the allegations are true. Thus, if a jury concluded that there was a 51 percent probability the plaintiff's claim was justified and a 49 percent probability that the defendant's assertions were true, the plaintiff would win, even though, essentially, the case is evenly split between the two parties.
In contrast, in criminal cases, the plaintiff (i.e., the government) must prove its case "beyond a reasonable doubt." This standard--which equates to the plaintiff establishing a more-than-90-percent probability that the allegations are true--is designed to prevent the conviction of innocent persons. It offers significant protection to innocent defendants. Unfortunately, this standard, and its protection, applies only in criminal cases.
It is often not difficult for plaintiffs to present enough evidence to get over the low 50-percent burden-of-proof threshold in a civil case. This especially is true because "expert" witnesses readily offer their services to plaintiffs. Experts also play a significant role in convincing juries that the plaintiff suffered significant monetary damages.
Often "experts" line up on either side of a case, and then offer "expert" opinions that are exactly opposite to each other. For example, it is not uncommon to see a physician hired by the plaintiff testify that the plaintiff has a 15 percent permanent disability to his back, while a similar expert hired by the defense testifies that the disability is actually 5 percent, or simply nonexistent.
Studies have questioned the validity of experts' opinions. They point out that the wide divergence of expert testimony in a particular case conclusively proves that "experts," in many cases anyway, merely are offering their personal opinions, which may be based on conjecture, their own perception of their skills, their personality, and the payment of their fee. Sadly, this is true in criminal, as well as civil, cases.
Nevertheless, in our legal system, if an expert has the credentials, the testimony may be accepted as if it were a simple incontrovertible mathematical formula. That the plaintiff can use an expert in this way may allow the lawsuit to meet the relatively low burden of proof in the case, even when the defendant attempts to counter this testimony with his own expert. The fact that the defendant will have to personally pay the expert's fee may put the defendant at a disadvantage, since the plaintiff's lawyer is likely covering the cost of their experts as part of the contingent fee arrangement.
The liberal availability of pre-trial discovery can work against either party to a case. Through pre-trial discovery, the each party is forced to answer an opponent's questions under oath and to provide copies of all relevant documents in his possession, or under his control, even when this evidence is extremely damaging to his case. Defenses to pre-trial discovery are extremely limited. This underscores the importance of having a plan for pre-trial discovery.
Be aware of the tools of pre-trial discovery. The specific tools of pre-trial discovery include interrogatories, depositions and requests for documents.
While the usual tools of pre-trial discovery include interrogatories, depositions and requests for documents, other pre-trial discovery tools exist. For example, in a case in which the plaintiff alleges he suffered personal injuries, the defendant could have a physician retained by him examine the plaintiff.
The intent of pre-trial discovery is to force the parties to reveal weaknesses in their cases and, thus, to encourage the parties to settle the case, or at the very least narrow the issues for trial. There are a few defenses that will allow a party to refuse to answer questions or turn over documents, but in nearly all cases the scope of discovery is broadly construed. As a result, a party will be forced to answer questions or turn over incriminating documents that will seriously harm their case.
Failure to cooperate with discovery results in sanctions. Generally, a party can be forced to disclose anything that may be relevant to the case. Failure to comply with such requests can result in serious consequences, including:
Further, because of the liberal nature of discovery, a plaintiff can use requests for documents to overwhelm a defendant. The cost and time involved in complying with such requests can be tremendous. This is not always a mere side effect. It is sometimes the very intent of a strategic decision by the plaintiff's counsel.
Defenses to avoid answering questions or producing documents during pre-trial discovery are very limited. The Constitutional right against self-incrimination simply does not extend to a private civil action.
Irrelevant information can be withheld. If requested information is truly irrelevant to the other side's legal case and could not lead to other relevant information, you can refuse to answer a question or turn over a copy of a document. However, this defense rarely applies, partly because the courts broadly construe relevance in itself.
Attorney-client privilege can protect information. Attorney-client privilege is a solid defense, but it seldom applies. It will apply only to private, confidential communications between an attorney and client. Neither the attorney nor the client can be compelled to reveal such communications. Protected communications can take the form of person-to-person communications, telephone calls, letters, etc. Bear in mind, that there is no "accountant-client" privilege, so any information provided to your accountant is fair game for discovery.
Be cautious! The law limits this privilege to private, confidential communications with an attorney retained to act on your behalf. The privilege may be lost where the communication is made in an open area within the hearing of other people, or in a private area within the presence of other persons not connected to the case.
In short, the courts broadly construe the right to pre-trial discovery and the use of pre-trial discovery tools, while defenses are narrowly construed. As a result of the consequences of pre-trial discovery, a party may be forced to reveal the very evidence necessary for the other party to secure a win.
Most people are aware of remarkable cases where juries have awarded millions of dollars to plaintiffs who appeared to have injured themselves or suffered only relatively minor injuries. The media is quick to report such cases, precisely because the results are so astounding.
In theory, frivolous cases should be dismissed before the trial ever begins based on motions for "judgment on the pleadings" and for "summary judgment." However, in reality, there is an extremely strong presumption that a plaintiff should be allowed to present a case to the jury who are the triers of fact.
This can present a problem for a defendant. Many times, juries decide cases based on their emotional response to the situation presented. A defendant may have a solid defense that proves he did not cause the plaintiff's injuries, but a plaintiff who nonetheless suffered serious injuries may invoke sympathy from the jury.
This sympathy can easily result in a substantial judgment for the plaintiff. This is why the jury selection process is of the utmost importance in preparing for a trial. These days, it is generally understood by trial attorneys that the make-up of the jurors represents the most important factor in the outcome of many cases. In fact, an entirely new profession has recently developed: the jury consultant.
Prior to the trial, jury consultants, who usually are psychologists or sociologists, will stage mock jury trials, conduct surveys, etc., and then prepare a profile of the "ideal" juror. This profile will be based on factors such as age, race, ethnicity, gender, religion, political party affiliation, etc. Studies have shown that such profiles play a very important role in the outcome of a case.
Using this profile, attorneys can use peremptory challenges to eliminate potential jurors who do not fit the profile during voir dire, or the choosing of the jury. While limited in number, the peremptory challenges offer an important advantage--the attorney needn't offer any explanation to justify the elimination of a potential juror.
Once a case reaches the jury, any result is possible. When it comes to juries, the sympathy factor cannot be overlooked, especially because the jury may be intentionally skewed by a party to respond to this factor (see our case study on jury trial judgments).
In short, a case that is not voluntarily settled usually will reach a jury. The jury may be configured to favor a particular outcome and may decide the case on an emotional basis. These facts do not bode well for the defendant. The result may be exacerbated by the fact that the rules of evidence may prevent the jury from hearing significant evidence.
During a trial, the judge will rule on what evidence is admissible and what evidence is to be excluded, and thus hidden from the jury. This further exacerbates the risks of a jury trial. With significant evidence hidden from the jury, the jury's conclusions may not produce a just result.
A jury awarded two individuals approximately $2 million in monetary damages against a Miami hotel. The two plaintiffs were shot while staying as guests at the hotel. They sued the hotel for negligence, on the grounds that the hotel failed to provide reasonable security.
At first glance, a finding of negligence doesn't seem to be that outrageous. However, the jury was unaware of one key fact. The police concluded that the two plaintiffs were shot when they were involved in a drug deal that went awry. The jury was never aware of this fact, as the judge ruled that this evidence was inadmissible.
The judge invoked a commonly used rule of evidence that dictates evidence is inadmissible when the "prejudicial effect" of the evidence outweighs its "probative value." The "prejudicial effect" refers to the likelihood that a jury would act emotionally and seize on this one piece of evidence to decide the case, while ignoring all of the other evidence. The "probative value" refers to the extent that the evidence actually proves an essential element in the case. The presumption really is that juries lack the intelligence to be able to properly weigh evidence, which of course is a logical inconsistency.
Apparently, in this case, the judge believed that upon hearing this evidence the jury would have immediately found that the defendant was not negligent, based solely on this one piece of evidence.
Negligence is one of the most common causes of action that will be brought against a small business owner, potentially exposing you to significant liability issues. The essence of negligence can be reduced to one word--carelessness. Unfortunately, it is not hard to find something that, at the very least, resembles carelessness in most cases. Hardly anyone acts flawlessly in all situations.
Technically, a defendant is supposed to be held accountable in a negligence action only if his conduct fell short of what a "reasonable person" would have done under the same circumstances. However, a plaintiff only needs to establish by a "preponderance of the evidence" that a "reasonable person" would not have acted (or failed to act) as the defendant did. This makes it easy to win in most negligence cases.
In many cases, the existence negligence may not be the real issue that the jury must decide--the real issues may be the amount of damages that plaintiff should receive to compensate for the injuries caused by the negligence. For example, it would be unlikely that any question would exist as to whether a driver was negligent if he crashed his car into the rear of a car at a stoplight; this issue will be "how much does the plaintiff get."
In theory, compensatory damages, in a tort action such as negligence, are supposed to merely make the plaintiff whole. This is not usually what happens in practice. People who are severely injured will never be made whole and, thus, are under-compensated. On the other hand, many people who exaggerate or simply fake their injuries, and rely on experts to bolster their claims, are frequently over-compensated.
Usually, the largest components in a damage award will be subjective and not verifiable in any substantial way. The award consists of:
Only past medical bills and past lost wages are objective and verifiable. Of course, exaggerating or faking injuries can produce even these items. Future medical bills and future lost wages necessarily are the product of estimates, and thus more subjective. Experts, who are hired by the plaintiff, can easily exaggerate these estimates.
The last element in the formula, namely "pain and suffering," is the most subjective of all and, in many cases, is the largest component in the award of damages. The jury, of course, is the ultimate group that will decide on the amount of the award. Unfortunately, expert testimony, along with emotional appeals to the jurors, are likely to be the most successful in terms of the pain and suffering component of the award.
In a civil case, if the plaintiff can enlist the help of the government, the defendant will be at a significant disadvantage. The resources available to the government can be staggering.
Plaintiffs may find that it is difficult to motivate a government agency, such as a state's attorney general's office, to bring or join a case. However, when there are allegations of fraud, and especially when there are multiple allegations by different parties, the defendant may find that the entire weight of the state or federal government is brought to bear against him. When this occurs, even the wealthiest of defendants will be at a significant disadvantage.
One of the most common ways this can occur is though the Federal Trade Commission (FTC) Act, or one of the state statutes based on the federal act. The FTC Act outlaws "unfair and deceptive" business practices, a term extremely broad in scope. In fact, the courts so broadly interpret the term that it extends to any type of business activity that might be construed as unfair. Further, each state has its own version of the FTC Act. Finally, the FTC, and 15 states, also regulate franchises.
Under these acts, the federal and state governments have the power to investigate complaints, levy civil fines and initiate lawsuits. In addition, unlike the FTC Act itself, the state versions of the FTC Act also authorize individuals to file private lawsuits. When an action is brought under the state statutes, successful plaintiffs may recover reimbursement of attorney's fees, court costs and punitive damages, in addition to compensatory damages.
The Racketeer Influenced and Corrupt Organizations Act (RICO) also is an effective way to involve the federal government in a case. RICO authorizes the government to investigate complaints, levy civil fines and initiate lawsuits, and similar to the state versions of the FTC Act, it authorizes private individuals to file suits in which they may seek reimbursement of attorney's fees, court costs and punitive damages, in addition to compensatory damages.