February 2013

 An Ounce of Prevention:  Avoiding and Minimizing Costly Litigation and Business Disputes

Craig L Winder, Esq.

Business owners are often disheartened by the seemingly inevitable prospect of suing or being sued at some point during their business ventures.  Sources of litigation and conflict can include customers, current or former employees, competitors, partners and investors.  This article provides a summary of simple but vitally important measures that business owners can take in an effort to avoid and minimize the effects of litigation and business disputes. 

1. Form an Entity.       There are myriad forms of legally recognized business entities, the most common being the C corporation, the S corporation, and the limited liability company, or “LLC”.  Each has distinct advantages and disadvantages, and a business owner should meet with his or her accountant to determine which entity makes sense from a tax perspective.    Business entities are “legal persons.”  In other words, the law recognizes the assets of such entities as being separate and distinct from the assets held by such entities’ owners.  Accordingly, business owners should always form a legal entity to protect their personal assets from seizure in the event of a judgment against the business.  

Note, it is vital that a business owner make sure that the business entity is adequately capitalized, and that proper corporate formalities are observed, including and especially the maintenance of separate personal and business funds.  Otherwise, a court may determine that the entity was merely an “alter ego” of its owner, and “pierce the corporate veil,” which exposes the business owner and his assets to judgment and seizure.  

2. Purchase Appropriate Liability Insurance.   Too often, business owners do not know what their general liability policy covers, or, more importantly, what it does not cover, and, as a result, find themselves figuratively without a swimsuit when the tide goes out.   Often, a basic general policy covers only claims made by third parties (for example, the guy who slipped on the banana peel and fell while on the business premises).  Often, it does not cover second party disputes, i.e. claims brought by a customer or client who contracted with the business for services (think legal, accounting, yard care, construction, etc.).   

The solution:  Sit down with a good insurance agent.  Talk with him about your business.   Obtain the appropriate endorsements for your policy.  Service-oriented businesses should consider purchasing an errors and omissions policy.  If a business owns a car, or requires its employees to drive a motor vehicle on behalf of the business (even if it is the employees’ own car), motor vehicle coverage is recommended. 

3. EXECUTE a WRITTEN Partnership or Founder’s Agreement.    Preferably at the beginning of the venture, before you start making money.  Too often, individuals who go into business together enjoy a high degree of mutual trust, and see no need for any kind of a written partnership arrangement.  

But a partnership agreement is not an act of mistrust. It’s an acknowledgment of the possibility that two or more of these high-character individuals may eventually see things differently.  Or that one of them may get bored with the business and want to leave.  Or that one of them may unexpectedly die.  Without a partnership agreement, misunderstandings or unforeseen events may lead to a breakup of the partnership. 

A basic partnership agreement should answer the following questions:

·         Who owns what?

·         When can the company redeem a partner?  At what price?

·         When can a partner transfer his ownership?  At what price?

·         What can a partner do, and what can’t he do, while a partner?

·         After a partner leaves the company, can he compete?  What information can he utilize?  Can he take other company personnel with him? 

·         What happens to a partner’s interest in the event of a death, divorce or crime?

4.  When Attracting Investors, be Sure You are Compliant with state and federal securities regulations.   You have heard the three biggest factors in determining whether to purchase real estate:  location, location, location.  Similarly, before taking an investor’s money, a business owner must do three vital things:  disclose, disclose, disclose.  State and federal securities regulations are broader in scope than most business owners realize.  Before seeking investors, hire an attorney to help you navigate these laws, which, if violated, can result in extensive investigations and heavy fines.

5.  Take the time to vet and train your employees.  Utah courts recognize two employee-related doctrines by which legal action may be brought against an employer:  Negligent Hiring and Negligent Supervision.  It thus behooves business owners to thoroughly vet and train their employees.     

Vetting is more than doing a criminal background check.  A background check reflects only a job applicant’s criminal history.  Thus, there may be relevant information about a job applicant that a background check will not reflect.  Conduct a thorough interview.  Require applicants to provide work references.  Check them.  Recent vetting trends include reviewing an applicant’s Facebook page, and checking an applicant’s credit history.

Once you have hired an employee, be sure to train him or her on all applicable laws and regulations.  Let your employees know that their inappropriate actions could expose you to a lawsuit.  Consider distributing to each of your employees an employee handbook containing the company’s best practices, policies and procedures.  Review the provisions of the handbook regularly through emails and periodic employee meetings.      

CONCLUSION

The above list is by no means exhaustive.  But undertaking the actions described in this summary can help business owners avoid or mitigate the risk of litigation and business disputes, and free themselves to do what they do best:  run a business.

Finally, this article does not constitute legal advice.  Because facts and circumstances vary, business owners are strongly encouraged to seek the advice of an experienced attorney when determining what actions to take for their businesses.