Lawsuits On the Rise for Small Businesses
By Al Davis
A new study by the US Chamber of Commerce published in December 2023, finds that small businesses are getting hit with a disproportionate share of lawsuits that result in them paying out billions in damages. The study, using the most recently available data from 2021, found that liability costs of lawsuits against businesses in general totaled about $347 billion, with small businesses accounting for about $160 billion of that total.
Despite small businesses only representing about 20% of total revenue earned by those surveyed, these companies were responsible for about 48% of 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 of $50 million or more.
Furthermore, the survey 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.
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: Small businesses of less than $1 million were estimated to be self-
insured for 74% of the cost of tort cases.
Time to Re-think the
Risk Equation?
Smaller businesses tend to be self-insured and incur a significant amount of risk by not purchasing insurance or having low policy limits. They 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 under-insured or uninsured. Ultimately, the cost of risk is greater for them, whether insured or uninsured.
“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 among small-business owners could be a lack of insurance. Most either lack insurance or are severely underinsured, according to a survey by market specialist Hiscox. The study found that 75% of small businesses are underinsured. For small businesses operating 10 years or more, 39% have never updated their general liability insurance.
The Attorney Value Proposition
So, the real question is how can small business owners 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 reputable law firm that specializes in helping the business proactively mitigate litigation risk.
While attorneys can appear expensive for smaller enterprises, law firms that specialize in working with small businesses sometimes have fee arrangements that make their services more affordable. For example, they might have arrangements where they work 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, attorneys with specific vertical market experience are particularly valuable in the small business arena. They are often more quickly able to conduct a risk assessment of the areas in which a company may be potentially vulnerable from a legal perspective, based on their experience with that industry.
Small business owners also need to ensure their corporate structure limits their liability. It’s important to consult an attorney and seek advice on the best corporate structure to limit corporate and personal liability in the event the business faces legal action.
Attorneys can also provide critically important feedback regarding the best way of obtaining the appropriate insurance to mitigate lawsuit costs, should they occur. Counsel will have a broader view of the insurance marketplace and, often, be able to find the most competitive rates.
Similar to law firms, insurance agencies with experience in the company’s industry also offer a strong value proposition. They can provide key insights on the appropriate type of insurance, policy limits and deductibles for the business.
While it’s hard to mitigate every risk that can lead to a lawsuit, taking a proactive approach in understanding these threats, along with having the right team of legal and insurance professionals, goes a long way in helping a small business manage risk. Their future existence could depend on it.
Al Davis serves as Principal at Revitalization Partners LLC, a corporate and board advisory firm that specializes in restructuring and receiverships. He is a Court Appointed General Receiver in the State of Washington as well as an interim CEO and advisor to middle market companies. He can be reached at adavis@revitalizationpartners.com or 206.903.1855.
