There are now over 1.2 million lawyers in America. That’s one practicing lawyer for every 266 people, and triple the number in the 1970s. The US is home to 70% of the world’s lawyers, and has three times as many per capita as the UK. An onerous consequence of hyper-minting law degrees is the litigious culture we have incubated.
Litigation costs account for 1.7% of US GDP—that’s 2.6 times higher than the EU average. A 2015 study by Clements & Co. found that 55% of US respondents said their firm was the target of at least five lawsuits in the previous 12 months. Most US companies spend between one and five million dollars on litigation per year, excluding settlements. In the majority of developed nations, that figure is $500,000 or less.
Another reason for the litigious culture is the use of contingency-fee lawyers. The practice is banned in Spain, France, Australia, and parts of Canada, but alive and well in the US. This acts as a huge motivation for excessive litigation, often leading to absurd lawsuits.
Crazy lawsuits, like these filed against Subway and Starbucks, can make for a head-shaking read and a good laugh. However, given the number of foolish legal claims that are thrown at small businesses, it’s not funny.
In 2008, the tort liability cost for small businesses totaled $105 billion, around 11% of their total revenue. Of this amount, one-third wasn’t covered by insurance and was paid out-of-pocket. So, why are lawyers honing in on small businesses?
Firms with annual revenue under one million dollars are hit with 57% of all lawsuits. Lawyers know that many of the cases are petty and will fail in court. They also know that many small businesses will be forced to settle due to high legal and opportunity costs.
The National Federation of Independent Business estimates that the average cost to fight a lawsuit is $100,000 (versus $5,000 to settle). An out-of-court deal can run to about 10% of the average small business owner’s earnings. Still, it is often an easier and cheaper option with less emotional stress and wasted time.
Lawyers use a legal loophole to game the system with silly lawsuits in the hope of reaping settlements. The loophole lets a claim be filed for up to 21 days and then withdrawn without any financial penalties to the lawyers. This is just another version of the “throwing mud at the wall to see what sticks” ploy.
While lawyers are tossing mud for fun, the impact on the victims is anything but.
This lawsuit against a small restaurant in Portland, Oregon is a good example. A woman filed a lawsuit for $100,000 against Enzo’s restaurant for “humiliation.” The case was settled for an undisclosed amount.
Perhaps the best example of the ruinous effects of empty claims hails from Washington, DC. In 2005, Roy Pearson, an administrative law judge, filed a $54 million claim against a dry cleaner for losing his pants. The owners, the Chungs, decided to fight the case. They won, but the damage was already done. The Chungs were forced to close two of their three stores due to the financial and emotional toll of the case.
Even where no fault is found, frivolous claims can ruin the livelihoods of those tangled in the mess. Not content with targeting small businesses, lawyers have also marked high net worth individuals (HNWIs) as easy prey.
A survey by ACE Private Risk Services found that 82% of HNWIs that responded thought their wealth made them attractive targets for lawsuits.
Jeffrey O’Hara—a partner at Clyde & Co.—said, “If the defendant is wealthy, this increases the potential for being hit with a suit. A situation that otherwise might have been viewed as a ‘nuisance event’ by the victim is now seen as offering a potential windfall.”
Kevin Dunne, a partner at Sedgwick LLP, cited this case where a HNWI was singled out: Five male teens were horsing around when four of them got in a car and drove off. The last boy jumped on the car fender, fell off, and suffered a brain injury.
“Although all of them were essentially culpable for the accident, the plaintiff’s attorney only went after the rich father of one teenager.” The family’s insurance provided only $2 million in personal injury protection. Adds Mr. Dunne, “We settled for many millions of dollars more than the insurance they had.”
The survey also showed that HNWIs were aware of the threat but misjudged the litigation risks. Over half believed their liability was capped at about $5 million. Yet, the survey showed that recent personal injury settlements have been 3–10 times that amount.
The steep numbers are due to excessive punitive damages awarded in the US. Under Federal law, punitive damages must not exceed 10 times that of compensatory damages. However, in practice, they are often much higher. Punitive damages are non-existent in Europe; in Japan, the practice is banned.
Without a radical overhaul, the legal system looks ripe for ongoing abuse by lawyers. Here are some steps you can take to blunt the risk of frivolous lawsuits.
There is no surefire way to erase the risk of being the target of a frivolous lawsuit. However, there are steps you can take to lower your risk profile.
These steps involve using vehicles like trusts and life insurance policies, which can help provide asset protection from overreaching lawyers and courts. If structured correctly, these tools can also be used to legally minimize income and estate taxes.
For readers interested in reducing their taxes and protecting their assets, Riskhedge has just published a new special report by estate planning and tax expert Terry Coxon. Our free report contains a step-by-step guide on several options you can take to mitigate litigation risk.
To close, I will let Jeffery O’Hara sum up the importance of lowering your risk profile. “I can’t tell you how many people after a financially devastating lawsuit say to me, ‘I wish someone had talked to me beforehand about the risks I was facing and what it might cost.’”
Stephen McBride
Chief Analyst, RiskHedge