Best Practices: The Cost of Litigation

What exactly is the “cost of litigation,” and what impact will litigation have on a borrower’s ability to meet its loan repayment obligations?  There are the “out-of-pocket” costs of litigation which can be quite substantial: legal fees and costs; court fees and costs; receivership costs and fees; discovery costs including expert witness fees and costs, among other things.  Indeed, when an SBA lender is confronted with litigation with regard to an SBA loan, and expects to be reimbursed its litigation costs, it must file a litigation plan with the SBA and obtain approval of that plan ostensibly to ensure that all litigation costs that are expended by the lender are necessary, reasonable and customary.  See, SOP 50 57, Chapters 21 and 22.  But what about the impact of the non-financial costs of litigation? 

Many SBA borrowers have never been confronted with the threat of litigation.  Consequently, when the seemingly inevitable happens, the small business owner does not know what to expect or how to deal with litigation.  The “costs of litigation” are not part of the initial business plan, even though these costs can have a material impact on the borrower’s ability to meet its loan repayment obligations.  The actual direct financial costs are difficult to anticipate, and small businesses are generally not well prepared to deal with the unexpected, excessive, non-productive cost of litigation.  Rarely is there a “rainy-day” fund in anticipation of litigation. As many small business lenders know, small business owners will look to its lender to provide some guidance on how to deal with a problem that it was never trained to deal with.

In an effort to identify the problems that litigation poses for small businesses, the SBA Office of Advocacy commissioned a study that resulted in the publication of an article in October 2005 entitled “Impact of Litigation on Small Business.” Although now sixteen years old, the information and message provided by this article are still timely.  

The research and data collection effort for this analysis was quite extensive, and included publicly available information, case sampling, and the results of interviews and surveys of small business owners.  The types of matters confronted by small business owners are similar to those confronted by businesses irrespective of their size:  employee related issues such as EEOC complaints, workers compensation claims and on-site safety; business specific problems, such as intellectual property related problems and problems arising between contractors and sub-contractors; and, issues related to customer satisfaction.  

Not surprisingly, the non-financial costs of litigation are essentially no different whether or not a small business is involved in the matter.  The same types of non-financial costs are present whether the business is big or small:  emotional; loss of business to competitors; and changes to firm structure.  Emotional cost includes the distraction from the operation of the business.  Business persons are forward thinking; however, litigation requires significant time reliving past events.  That’s not very entrepreneurial.  

In the article, there are a number of “lessons learned” that are identified, including:  address all complaints in a timely manner; be less trusting of employees, customers and other companies; exert tight control over the company’s assets; be careful with paperwork and document complaints; and don’t be so naïve as to think that litigation will not find its way to the business’ door.

For those lenders who are funding a business where the principal is new to the business world, this publication may be a good resource to provide to the budding entrepreneur as she goes about establishing her business, and the internal processes and procedures in operating that business.   

For more information about the impact of litigation on small businesses, contact Norman at ngreenspan@starfieldsmith.com, or 215-390-1025.