Lawsuits are on the Rise for Small Businesses

 

A new study by the US Chamber of Commerce published in December 2023 found that small businesses are getting hit with a disproportionate share of lawsuits and they end up paying out billions in damages.

The study, based on statistics researched from 2021, found that the liability costs of lawsuits against businesses totaled about $347 billion, with small businesses accounting for about $160 billion of those costs.

Despite small businesses only representing about 20% of total revenue earned in 2021 of those surveyed, they were responsible for about 48% of the commercial lawsuit costs.

In fact, the smaller the business, the higher their share of liability as compared to revenue, with legal liabilities seven times greater for businesses with revenue under $1 million compared to businesses with revenue $50 million or more.

The survey has found that commercial tort costs for businesses with revenue of $1 million or less were more than $35 per $1,000 revenue earned. For companies with revenue over $50 million, they were less than $5 per $1,000 of revenue earned.

 

MOST DISTURBING WAS …

The most disturbing part of the survey revealed that businesses with revenues of less than $10 million were estimated to be self-insured for 61% of the cost of tort cases.

Even more concerning is that small businesses of less than $1 million were estimated to be self-insured for 74% of the cost of tort cases.

Smaller businesses tend to be self-insured and incur a significant amount of risk by not purchasing insurance or having low policy limits.

Small businesses often lack the economies of scale required to manage their liability risk and find that the cost of insurance is too great, or they fail to appreciate the level of risk they are assuming and choose to be either underinsured or uninsured.

Ultimately, the cost of risk is greater for small businesses, whether insured or uninsured.

 

STACKED AGAINST SMALL BUSINESS …

“The U.S. lawsuit system is disproportionately stacked against small businesses that already have enough to worry about,” said Chamber of Commerce Institute for Legal Reform President Harold Kim in a news release.

“Every dollar that small businesses pay into the tort system is a dollar that doesn’t go to hiring, expanding or making new products.”

Overall, the risk of commercial lawsuits grew by about 19% between 2020 and 2021, higher than expected after accounting for inflation and economic growth.

One potential reason for high litigation costs for small-business owners could be a lack of insurance. Most small-business owners either lack insurance or are severely underinsured, according to a survey by Hiscox.

It was found that 75% of small businesses are underinsured. For small businesses operating for 10 years or more, 39% have never updated their general liability insurance.

 

HOW TO AVOID THE COSTS?

So, the real question is how small business owners can avoid the cost of major lawsuits.

The first line of defense is to ensure the owner or CEO of a small business has a relationship with a law firm that specializes in helping the business proactively mitigate the risk of being involved in a lawsuit.

While attorneys can be expensive, law firms that specialize in working with small businesses sometimes have fee arrangements that make it more affordable.

They might have arrangements where they are on a maximum monthly fee and are available for consultation as needed to review contracts and consult on issues that could lead to lawsuits.

Given that every business is different, and risks vary depending on the industry a business is in, it’s important to have an attorney who has experience in your industry and to conduct a risk assessment of the areas that a business may be potentially vulnerable from a legal perspective.

 

LIMIT YOUR LIABILITY …

Small business owners also need to ensure their corporate structure limits their liability. It’s important to consult your attorney and seek advice on the best corporate structure to limit your corporate and personal liability, in the event your business is faced with a lawsuit.

Your attorney can also provide you with feedback regarding the best way of obtaining the appropriate insurance to mitigate the cost of lawsuits, should they occur.

Having an insurance agency that has experience in your industry is also important to provide their thoughts on the appropriate type of insurance, policy limits and deductibles for your business.

They will also have a broader view of the insurance marketplace and will be able to find the most competitive rates.

While it’s hard to mitigate every risk that could lead to a lawsuit, having a proactive approach in understanding the risk your business has, along with having the right team of legal and insurance professionals, will go a long way in minimizing the risk of costly lawsuits your business may face.

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering, a State Receivership or Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.