NFIB: 10 Ways to Stay Out of Court

The National Federation of Independent Business (NFIB) Legal Foundation recently released a list of 10 best practices designed to help businesses owners avoid legal trouble. According to Beth Gaudio, senior attorney for the NFIB Legal Foundation, the U.S. tort system costs more than $230 billion per year, a staggering $845 per person – with about 50 percent of this amount going towards legal fees. There are approximately 1 million attorneys in the United States – up from 100,000 at the beginning of the 20th century. Seventy percent of the world’s attorneys are located in the United States; 94 percent of the world’s lawsuits are filed here.

“With a dramatic rise in the cost of lawsuits, it is not surprising that many small-business owners fear getting sued, even if a suit is not filed,” Gaudio said in a recent presentation. “That possibility – the fear of lawsuits – is supported by an NFIB Research Foundation National Small Business Poll, which found that about half of small-business owners surveyed either were ‘very concerned’ or ‘somewhat concerned’ about the possibility of being sued. It’s no wonder that small-business owners rank the ‘Cost and Availability of Liability Insurance’ as the second most important problem facing small-business owners today. The only problem ranked higher is rising health-care costs.”

Gaudio says businesses take the brunt of punishment when it comes to litigation, noting that it’s small $5,000 to $10,000 out-of-court settlements – not million dollar verdicts – that can financially impair a company. “Estimates have shown that 90 to 95 percent of lawsuits are resolved, dismissed, abandoned or settled without getting to court,” Gaudio says. “In my experience, plaintiffs and their attorneys find ‘demand letters’ particularly attractive when they can file a claim against a small-business owner for violating a state or federal statute. Generally, the way it works is that an attorney, on behalf of a plaintiff, will send a one to two-page letter alleging the small business violated a particular statute, replete with cites to statutes and case law. At some point, the attorney’s letter states that the business owner has an ‘opportunity’ to make the whole case go away by paying a settlement fee up front.”

Demand letters often include timeframes for paying settlement fees, as well as “escalation” clauses that say the price will increase over time. For instance, a $2,500 settlement within 15 days may escalate to $5,000 if the business waits 30 days to pay. “When you consider that many small businesses only net $40,000 to $60,000 a year, $5,000 to settle a case immediately eliminates about 10 percent of a business’ annual profit,” Gaudio says. “Small-business owners also are troubled by the fact that they often are forced to settle a case at the urging of their insurance company. In most cases, if there is any dispute of fact, the insurer will perform a cost-benefit analysis. If the case can be settled for $5,000 the insurer is likely to agree to the settlement because generally it is less expensive than litigating, even if the small-business owner would ultimately prevail in the suit.” Settling a case will generally drive up a small-business owner’s business insurance premiums.  

“Rather than naively hoping that the lawsuit insanity will pass by, every small-business owner needs to develop a proactive strategy that will help prevent legal entanglements and defend your business should a plaintiff’s lawyer come knocking at the door,” Gaudio advises. She and the NFIB Legal Foundation offer the following 10 practices to keep legal troubles off the business radar screen or help companies be successful in the event that they are sued.

RULE #1: INCORPORATE. Many people who go into business do so as a “sole proprietor.” This means that they are doing business as an individual or a “dba” (doing business as). This scenario offers absolutely no asset protection and poor tax benefits. If the business is unincorporated, your personal assets will be at risk. For less than $100 in most states, you can form a corporation to do your business or trade. If properly maintained, a corporation will shield your personal assets if the business is sued or goes bankrupt.

Remember that a corporation is good, but only if you use it properly. Many people pay an attorney up to $1,000 to setup a corporation and its minute book and then stick it on a shelf. A corporation will not shield you from personal liability if you do not follow corporate procedures. Worse, if the IRS audits you, they can set aside the corporation and hold you personally liable for the taxes.

To protect your business, at least once a year it is a good idea to have your attorney or accountant review your corporate records.

RULE #2: KNOW THE LAW. Ignorance of the law is no defense. Make sure you’ve trained your supervisors on good personnel practices. All your employees should be aware of the laws regarding discrimination.

Another headache for small businesses is complying with the tax code – making sure you pay the right amount and file on time. Becoming an expert in all areas of business taxes is probably not realistic and so most small-business owners will hire a CPA or tax attorney.  However, while a professional can relieve you of much of the paperwork and make it easier to comply, it does not release you from responsibilities. For proper protection, make sure you understand the basics, such as:

• Does your company have or need an Employer Identification Number?
• Does your company have in place processes to meet requirements for Federal incme states, state employment taxes, Social Security, employees’ withholding certificates (Form W-4), immigration forms (Form I-9), minimum wage, overtime and child labor laws?
• Does your company have an orderly and safe record-keeping system that shows the company’s income and provides supporting documentation?

RULE #3: MAINTAIN ADEQUATE INSURANCE. Don’t be cheap. Insurance will protect you in most circumstances. If you keep the minimum insurance, increase the liability limits. You can usually double your liability insurance for a relatively small amount. Keep in mind that if your insurance is not adequate to cover the claim, the injured party can go after your personal or unincorporated business assets for the difference. Consider an umbrella policy, which provides excess liability insurance in the event of a truly catastrophic occurrence that would exhaust the limits of general liability coverage. Additional protection might also be available with Employment Practices Liability Insurance (EPLI), to respond to claims of employment discrimination. 

Insurance also gives you an attorney in an event you are sued, even if the claim is settled before trial. The duty of an insurer to defend (pay for your lawyer) is much broader than its duty to indemnify (pay for claims against you). Even if the lawsuit is bogus, the insurance company will provide you with a lawyer, saving you thousands of dollars, though you lose control over the choice of counsel and settlement decisions.

RULE #4. MANAGE EMPLOYEES FAIRLY & WISELY. Many employment disputes can be avoided by good personnel management practices. Small businesses don’t need to develop voluminous HR handbooks, however, by implementing a few fundamental policies you can mitigate employment disputes.

At the outset, make good hiring decisions. When it comes to hiring, an effective interview could be the most important step you take when it comes to picking the best applicant. In order to make an informed decision about a candidate’s job qualifications, it is important to gather as much information as possible during an interview. However, do not ask inappropriate questions that could be the basis for an employment discrimination complaint. Review applicants’ resumes in advance of interviews and prepare standard job-related questions that will enable you to pick the best candidate. Use the same list of standard questions for each interview. Be prepared to provide information about your company and answer questions from the candidate. Look and act professionally during the interview and show an interest in every candidate.

When an employee first starts, provide them with a job description that clearly defines their responsibilities. They should also receive a copy of the company’s discipline policy and code of conduct, if you have one. By providing this information up front, you can establish a framework to evaluate the employee’s performance and provide discipline if necessary.

Conduct regularly scheduled performance evaluations. The employee’s orientation should also set a timeframe for a performance review. Keep hard copies of all performance reviews in the employee’s personnel file. Reviews should not be inflated or inaccurate, and should give the employee an opportunity to improve if necessary.

As an employer it’s important for you to take action when you notice than an employee’s performance has deteriorated. Catching and addressing poor performance before it becomes intolerable is an easier and more effective way of dealing with performance problems than letting the problems languish. By tackling poor performance early, your company will benefit in the long run by improving employee performance, increasing morale and protecting against employment litigation.

Enforce company policies consistently. Be sure to retain written copies of warnings and violations in the employee’s personnel file. Finally, whatever the company’s discipline policy is, apply it to each employee the same way. These steps show a pattern of fairness and willingness to work with employees before turning to termination. As a general proposition, if an employee is told that he or she is being terminated, whether for performance reasons or misconduct, the employee should not be surprised. In almost every circumstance the termination announcement should be the culmination of a progressive discipline that has given the employee a clear signal they have not been performing up to expectations.

RULE #5. PROHIBIT DISCRIMINATION. Sexual harassment is a hot issue for the 21st century. If you own a company with employees, be aware of what goes on. Even if you don’t personally engage in any conduct that is harassing in nature, you can be sued if your company permits a “hostile” environment. 

Make certain you have written company policies that are given to all of your employees that specifically state that sexual harassment will not be tolerated. (For more detailed information on these laws, you should review the NFIB Legal Foundation’s Federal Employment Law Handbook, a resource that was specifically developed for small business owners.)

RULE #6: CLASSIFY YOUR EMPLOYEES CORRECTLY. Some of the most frequently litigated issues in recent years have involved the misclassification of consultants and salaried “exempt” employees under the Fair Labor Standards Act (FLSA). The FLSA applies to all full and part-time employees of any business with two or more employees and establishes minimum wage requirements, overtime pay, record-keeping and child-labor standards for full- and part-time employees.

Misclassification of an employee can be a very expensive mistake, with the potential for class actions seeking unpaid overtime for periods up to three years. Regularly review whether your employees are properly classified under the FLSA to avoid liability.
 
Finally, don’t forget the FLSA Record-keeping Requirements: If an employee is subject to the minimum wage provisions or both the minimum wage and overtime provisions, an employer must keep extensive payroll records.

RULE #7:  BE CAREFUL WITH INDEPENDENT CONTRACTORS. Employers need to be particularly cautious not to incorrectly classify a worker as an independent contractor, as the liability for doing so can be significant. It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.

If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty.

To determine whether or not an individual is an employee or an independent contractor, employers must conduct a fact-specific inquiry regarding the particular job duties of that individual. In conducting this inquiry, employers will use different tests under various employment statutes to help make their determination. Generally, these tests consider how much control an employer has over the worker (often referred to as the “right to control”) and whether the worker is dependent on the business of the employer for his livelihood. In applying these different tests, many factors will be considered, including: whether the worker is trained by the employer, who furnishes the necessary equipment, whether the services are rendered personally, how the worker is paid (by the hour as opposed to by the job), the duration of the employment and how the employer can terminate the relationship.

RULE #8: HIRE AN ATTORNEY. Although no one likes to think about it, in the course of your business, there probably will come a time when you will need the assistance of a lawyer.

If possible, interview two or three lawyers before selecting one. You should be comfortable with the lawyer you are working with, and he or she should have the necessary skills to win your case. On your interviews, be sure to bring the general points of your case and all the names, addresses and phone numbers of everyone associated with your case. At a minimum, ask the following questions:  

• How long have they been in practice? 
• How many cases like this have they handled? 
• Do they typically go to trial or are most of their cases settled out of court? 
• How much do they estimate this case will cost? 
• How long do they estimate this type of case will take to either settle or go to court? 

If you don’t understand something the lawyer is saying, ask for clarification. In order for you to feel comfortable with your lawyer, it is crucial that you understand what he or she is telling you. Don’t let the lawyer overwhelm you with legal jargon. 

Finally, be sure you understand the terms of your agreement with the lawyer. Don’t sign anything until you have time to review it and consider other offers. Changing lawyers is a last resort that should be avoided at all cost, so make sure you are comfortable with the lawyer you select.

RULE #9: GET IT IN WRITING AND KEEP IT. Document, document, document.  Whenever you speak with someone at another business, the IRS or any governmental organization, get it in writing. If they won’t give it to you in writing, send them a follow-up letter that summarizes your conversation. Their failure to object to its contents can be deemed an admission of what the letter states. Keep a copy to retain proof that the oral conversation occurred. Remember: It’s not what happens, it’s what you can prove in court! The written word is your most powerful weapon in court - use it.

When it comes to keeping documents, consider instituting a document retention policy. Many business owners are unsure as to how long they should retain business documents and records. A well-crafted document retention policy that is followed by your employees will benefit your business by promoting efficiency, saving your company valuable computer and physical storage space, and protecting your company in the event of litigation.

To obtain a model document retention policy and a more detailed listing of documents and applicable federal and state laws, check out the NFIB Legal Foundation’s Small-Business Guide to Document Retention.

RULE #10: WATCH WHAT YOU SAY & DO. If you are involved in what could potentially be a lawsuit, think before you act (and speak).

The best defense against a potential employee lawsuit is to treat workers fairly and honestly. An employee should always be told why he or she is being fired, rather than using the hard-line stand that a business can fire any worker for any reason.

When it comes to outside parties, do not write offensive letters to your adversary stating your legal positions. Successful litigation involves some element of surprise. State firmly, but vaguely, that you intend to pursue your legal remedies – that's all.

Lawsuits are hurting small-business owners, new business formation, and job creation. The growing number and costs of lawsuits, particularly those not based in fact, threaten to stifle significantly the growth of our nation’s economy by hurting a very important segment of that economy, America’s small businesses.  We must work together to find and implement solutions that will stop this wasteful trend. There are no guarantees when it comes to staying out of court. However, by assessing your risks you can help minimize your liability exposure.

Source: Beth Gaudio, senior attorney, National Federation of Independent Business Legal Foundation