As a small business owner, you know that starting a business involves risks. In today’s society, where suing is common, everyone faces some risk of being taken to court. Litigation, or being sued, is not just a problem for large companies; it can happen to small businesses, too, and it can be very costly and stressful.

Litigation risks, or legal risks, are the chances that someone might take legal action due to what a person or company does, doesn’t do, or because of its products or services. These risks can be very different depending on the area, country, and industry. Badly written contracts, careless business planning, and not knowing enough about rules or laws can lead to more chances of injury claims, long legal battles, and big expenses.

The best way to determine and deal with possible legal problems is to spot them early when planning your business and take steps to protect your new company.

Common types of litigation risks for small businesses

The financial and practical challenges of starting a business can often discourage people from pursuing their dreams of becoming entrepreneurs. Plus, there are legal risks that need to be handled to ensure the safety of your business in the future, including contract disputes, premises liabilities, products or services liabilities, employment disputes, intellectual property disputes, and more.

Below we’ve outlined some of the more common types of litigation risks for small businesses.

Contract disputes

This is the most common type of legal risk that businesses face. In fact, when running a small business, you might face many contract risks, such as disagreements with suppliers, customers, or service providers about what was agreed upon. With contract risk, there’s the risk of losing money because either someone backs out of a contract or your organization doesn’t properly handle the benefits or duties outlined in the contract. Plus, if your contract processes are flawed (manual errors, delays in finalizing contracts, non-compliant terms), your business could be at risk here, too.

Premises liability

Business owners are responsible for any injuries that happen inside their business or on their property. This means the place where your business is located can be a source of legal risk. For example, if someone trips, falls, and gets hurt while visiting your business, they could sue your company and ask for money to cover their injuries and other costs like lost wages or medical bills. That’s why it’s important to have proper policies and procedures in place to handle potential dangers, like wet floors or icy sidewalks, to keep your small business protected.

Product or service liability

Product liability involves selling a defective product that ends up hurting someone. Service liability is similar but involves a company’s services harming a customer. No matter what kind of business you run, there are legal and financial risks linked to the services you offer or the products you make, distribute, or sell. If your products are faulty, your services are not good, or you don’t give enough warnings, customers might sue your business.

Employment disputes

Many small businesses rely on their employees to help their business succeed. That’s why knowing about common issues like harassment, wage disputes, and Workers’ Compensation can help protect your business from costly lawsuits and damage to your reputation. Common employment issues often involve harassment, discrimination, and problems with wages, overtime, and salaries. Learning about these common disputes can help you create a better workplace for your employees and improve your experience as a small business owner.

Intellectual property disputes

Sometimes businesses use trademarks or designs from other companies because they like them and think there won’t be any problems. However, this is not true. In fact, small businesses can face accusations of infringing on another’s trademarks, copyrights, or patents. To avoid getting sued over using someone else’s intellectual property, it’s crucial that your new business has a basic understanding of intellectual property law. On top of that, you might also need to defend your own intellectual property rights.

Compliance and regulatory issues

Your business might be subject to rules set by government bodies, commissions, or agencies. It’s important to know exactly which regulations apply to what your company does. You also need to understand the specific rules, like specifications, policies, standards, or laws you need to follow to avoid fines or legal issues.

How to mitigate the risk of litigation for small businesses

Litigation can be stressful, costly, and time-consuming. Here are some simple tips to help reduce the chance of legal problems for a small business.

Understand and comply with legal requirements

First, you should understand the laws that affect your business. This includes rules at the federal, state, and local levels. Make sure you are following all the rules related to your employees, your contracts, and any specific laws for your industry. Keep up-to-date by attending workshops, subscribing to legal updates, or talking to lawyers.

Write and review contracts carefully

Strong contracts are key to smooth business operations. Every contract should clearly spell out everyone’s responsibilities. It’s also a good idea to have a lawyer look over your contracts regularly to ensure they’re complete and up to date.

Implement and enforce company policies

Write clear policies on important issues like workplace behaviour, sexual harassment, and how to handle company data. Make sure every employee gets a copy of these policies and understands them. Hold training sessions to review these policies regularly.

Keep detailed records

Good record-keeping can protect you if you face a lawsuit. Keep detailed records of everything from finances and employee information to customer interactions and safety checks.

Use waivers and disclaimers

If your business involves risks (like physical activities), having customers sign waivers can protect you from some lawsuits. Disclaimers can also limit your liability, especially if your business offers advice or information.

Get the right insurance coverage

Insurance can cover you against many types of legal claims. Look into different kinds of small business insurance like general liability insurance, professional liability insurance, and product liability insurance.

Train your employees

Employees who know how to do their jobs properly and understand your company’s policies are less likely to cause issues that could lead to legal problems. Provide regular training in safety and compliance.

Handle disputes proactively

Try to address complaints and disagreements internally before they escalate to lawsuits. Methods like mediation or arbitration can help solve disputes without going to court.

Consult legal professionals regularly

Regular advice from a lawyer who knows your industry can help you avoid many legal problems. They can give you specific advice and help you understand complex issues.

How to identify your business’s litigation risks

Identifying the risks of getting into legal trouble for your business involves looking closely at different parts of how you operate. Here’s how you can identify your own small business’s litigation risks:

Review your business operations

Look at everything your business does, from selling products to dealing with customers and managing employees. Think about what could go wrong in each area. For example, poor customer service practices could result in customer complaints or lawsuits, or if you don’t treat your employees fairly, it might lead to disputes over wrongful termination or discrimination.

Analyze any past incidents

Review any legal issues your business has had before. Look at what happened and see if there are any patterns. For instance, if you’ve had trouble with suppliers not delivering what they promised, you might need to find new suppliers or change your contracts.

Review your contracts

Go over all the contracts your business has signed with customers, suppliers, landlords, and employees. Pay attention to what’s written in these contracts and any disagreements that might come up so you can fix any issues before they become bigger problems.

Evaluate compliance requirements

Check that your business is following all the laws and rules that apply to it. This means things like paying your employees fairly, keeping your workplace safe, and following any industry-specific rules. If you’re not sure, get some advice or do some research to make sure you’re doing things right.

Consider industry-specific risks

Some businesses have more risks than others because of the type of work they do. For example, businesses in highly regulated industries such as healthcare, finance, or food service might get watched more closely and have to follow more rules. Also, businesses that deal with intellectual property, such as technology companies or creative agencies, may face risks related to copyright or trademark infringement.

Conduct a financial risk assessment and analysis

Consider the potential financial impact of legal disputes on your business. While this includes paying lawyers, settling claims, and paying for any damages, it also means thinking about other costs, like how your business’s reputation might suffer, how you might lose customers, or have trouble running your business. Conduct a financial risk assessment and analyze how much each type of legal dispute could cost you, so you can focus on preventing the ones that could hurt you the most.

Develop a risk management plan

Once you know what risks your business faces, create a comprehensive risk management plan to address them. This plan should outline specific measures and strategies to prevent, mitigate, or manage legal risks. This might include implementing new policies and procedures, getting additional insurance, or seeking legal advice when needed. Keep reviewing your plan and updating it as your business grows and things change.

Seek professional advice

If you’re still unsure about your business’s risks or how to address them, consider seeking advice from legal professionals who specialize in business law. A qualified attorney can provide valuable insights and guidance tailored to your specific industry and circumstances.

How does having insurance help mitigate litigation risk?

Having insurance can help small businesses by paying for legal expenses when facing a lawsuit or legal claim. If your business is sued, the insurance can cover legal fees, court costs, settlements, and damages, which can be very expensive. This means you don’t have to pay for these costs out of pocket. Having the right small business insurance gives business owners peace of mind and lets them focus on running their business(es) without worrying about legal problems.

FAQs

What are potential litigation risks?

Potential litigation risks are things that could lead to your business being sued, like unhappy customers, contract disputes, or not following the law.

How do you manage litigation risk?

To manage litigation risk, you should understand the law, have clear contracts, follow rules, and be careful about what you say and do in your business.

What is audit litigation risk?

Audit litigation risk is the risk that a company’s financial statements could be challenged or disputed, leading to legal action, often related to audits performed by accounting firms.

What is the most common type of legal risk?

The most common type of legal risk for businesses often involves contract disputes, where parties disagree about what they agreed to in a contract.