The amount of money you spend paying a contractor to perform small repairs, improvements or major construction-related projects could be small compared to potentially greater costs resulting from a dispute with the prime contractor or any of the subcontractors they hire. Stricter laws and regulations offer some protection against unlicensed contractors; however, if you are like many small business owners, you may not know what questions to ask or what resources are available to you to help you screen contractors during the bidding process. To help us understand what we can do to avoid the risks associated with working with contractors, we are happy to be joined once again by attorney Virginia Suveiu, specializing in commercial and contract law and developer of the Legal Risk Management Certificate Program at the University of California, Irvine.
Now it's being seen more as an objective and something that is vital to not only the company's well-being but vital to the company's future well-being as well.
- Virginia Suveiu
Jeff: I'd like to start by talking about just basically in terms of legal risks, tell us how much of a concern this should be to a business owner in addition to all the other things that he or she has to be concerned about with respect to their companies?
Virginia: Sure, again, a pleasure to be with you and your audience. One of the most important aspects that I like to talk to and especially when I first open up the concept of legal risk management to my students is the issue of perception. We perceive that we may know a lot about our industry because we've been in our industry for several years. We perceive that we know how to handle certain issues, certain aspects because we've been through certain cycles before. In any industry be it a large company, a small company, apparel or aerospace and defense, you do have that mentality of “We've seen it and we've done it, and we're good to go.” What is changing, however, especially in the last few years is the perception with regard to legal risk management. Very interesting 2013 study by Accenture which is a management consulting firm, they did a global risk management study and that included legal risks. And they reported that 98 percent of those surveyed respondents reported an increase in their perceived importance of risk management, which also includes legal risks, at their organization. So essentially a conclusion was: today we've categorized legal risk management as very important. It enables execution, it enables our achievement of our objectives. Legal risks are number one on the list of top risks expected to rise over the next few years, just given of the changes in regulatory matters, globalization, and other aspects that are coming down the pipe. What's interesting about this study and then also with interactions that I have with business owners, the interactions that I have with students, interactions that I have with other professionals, they tell me risk management used to be seen as a bump in the road, something that we really don't want to spend too much resources on that because we have everything under control. Now it's being seen more as an objective and something that is vital to not only the company's well-being but vital to the company's future well-being as well.
Now it's being seen more as an objective and something that is vital to not only the company's well-being but vital to the company's future well-being as well.
Jeff: I've mentioned at the top about the potential damage on a company's value. Do you believe that that's true? Is there something to the effect that litigation and legal challenges, and the financial cost that come with those can have a damaging effect on a company's value even years after this stuff has gone by the wayside, things have been fixed, things have been repaired, and the company has had fantastic revenue growth? Is it true that there can be a lasting impact on the company in its perceived value?
Virginia: Certainly. There are several matters to go in. I actually looked up certain statistics with regard to litigation since you mentioned that. And litigation is certainly a big worry and legitimately so for many business owners and business professionals in general. What I like to do is I like to include various studies and various statistics, and those help for instance to bring home the principles with regard to legal risk management, to students and other people that I give presentations to. One of the more interesting studies was done fairly recently in 2012 by the National Center for State Courts in cooperation with the American Board of Trial Advocates. American Board of Trial Advocates is a very important, one of the largest, most active professional organizations in the country for litigators. What they found was their study was done on 43 general jurisdiction courts, so they are the first courts that you go to, so akin to our superior courts in California. They've looked at median cost of litigation by case type. One of the more interesting ones, for instance real property case types, average cost would be $66,000. Employment average cost would be $88,000, and contract disputes, $91,000. And this can be found if people want to look at the study courtstatistics.org. So litigation is one aspect to look at. And people think while we do have a policy in place or we do have certain... regarded in those areas. But litigation, it's just one piece of the puzzle.
As I've mentioned before, regulatory compliance is going to become more and more of an issue to handle, why? Over the last few years we've had tens of thousands of regulations come down the pipe from Washington, D.C., and a very interesting study by the National Association of Manufacturers, and this was just from 2014. Complying with federal regulations cost around 2 trillion in lost economic growth annually, or roughly equivalent to 12 percent of total national GDP. The study which was conducted by economists Nicole and Mark Crain concluded that manufacturing, so they're talking strictly about manufacturing in this study. Manufacturing businesses face disproportionate share of the burden, or around $20,000 per employee, per year, nearly double what the average US business pays to comply the federal rules. Here's another important point that will probably ring true to certain members of your audience. Small manufacturers pay more than three times as much as the average US firm. That is around $35,000 per employee, per year that small manufacturers instead could use to grow their business and create jobs.
Virginia: So you have two aspects, you certainly have the litigation aspects, and usually the general counsel of the company, or the attorney that the company works with usually can handle the litigation areas well because you understand your industry and you understand the culture of your company, you understand what litigation risks tend to come up. But the more risks are involved, especially with regulatory compliance, so that could be anything from environmental regulations to if you want to go into federal government contracts, you have the far federal acquisition regulation, there are just a myriad. And it's important to understand not only your business, your company, but understand the industry you're in and see what potential regulations coming down the pipe could affect your industry and consequently your business.
And it's important to understand not only your business, your company, but understand the industry you're in and see what potential regulations coming down the pipe could affect your industry and consequently your business.
Jeff: Interesting point. So really depending again on the industry. There may be certain types of legal risks that you face that certainly other industries may not or maybe they don't have quite the exposure that your industry does and certainly with regard to manufacturing, there's really a whole host of possibilities out there lying in wait, and you've just talked about how much, it just seems like the legal risks for manufacturers far outweigh those in other industries or in other sectors, let's put it that way. But having said that, Virginia, what do you believe are the most significant legal risks that most companies regardless of industry face today?
Virginia: I think a very important aspect ... So with legal risk management we're talking about, it's like an umbrella concept. We have several areas of the law that fall under legal risk management. However, one of the more important areas under the legal risk management umbrella if you will is contract risk management, because with businesses it's just business in general. It's just based so much on the contractual relationships, be it contracts between private entities, or be it contracts with the state or federal governments. So contract risk management is an essential component of managing legal risk. We talked briefly about legal risks but the essence of legal risk management is the process of analyzing the organization's exposure to risk and determining how to best handle such exposure. It's the process of identification, assessment, and prioritization.
With contract risk management what we're looking at is contract risk evaluation as well as other areas of identification. We may be looking at evaluation of the likelihood and consequences, of identified risks, implementation of risk avoidance, engagement in risk reduction, use of insurance, use of risk transfer, those sorts of matters. So contract risk management is one area. Another area that you will see especially if a company is doing business internationally is the issue of Foreign Corrupt Practices Act. The US Department of Justice is continuing to prosecute violations of Foreign Corrupt Practices Act and they're making it a top priority. I give the Foreign Corrupt Practices Act as an example because it's also important to understand where is the government looking at to enforce. So you want to see where is enforcement coming down from, the government. And that's very critical point when we're talking about risk management. Are your policies up to date, how have you responded in the past? And to be able to better respond to those risks one of the most important areas to understand is how: are your people trained, do your employees understand not only the company's goals but also understand that risk management is essential to the company's health? One of the more important points as well is to be successful in any given business endeavor, we know that business leaders have to communicate with others. So from that we then see that board and management must reconsider their traditional risk approaches and demand better information from their employees to help them achieve their organization's objective.s A lot of it has to deal with communication with key employees, and the employees who are working because what you see is the people closest to the work are those who best be able to identify what potential risks exist for the company in question.
Jeff: We're talking about managing legal risks and how important it is that you need to take a look at your company and find out where your weaknesses are, where you're exposed. You need to try to find out what it is that you don't know. And a good way to do that would be to consult your attorney, and you can also keep listening to this program. Because when we come back we're going to talk more about this very important concept, something that could really at the end of the day cause your company to lose a tremendous amount of money, cause a tremendous decline in value, and that would make it very difficult indeed for you to continue operating and also could put your future in jeopardy as far as that opportunity to sell or acquire other businesses and your business, to sell your business. Virginia Suveiu is my guest. My name is Jeff Allen and I'll be back with more when Deal Talk returns after this.
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Jeff: Welcome back to Deal Talk, my name is Jeff Allen and I'm here with my guest Virginia Suveiu, and she's an attorney, and she is also a teacher at UC Irvine, at University of California Irvine, the extension there for the contract management certificate program, and the legal risk management certificate program that she actually helped develop over there. I'd like to start this segment of the program by talking about why you believe that most businesses seem to come up short in protecting themselves against such risks. Is it just one of those things where when you're talking about documentation, you're talking about contracts, you're talking about tremendous volumes of paperwork, and language, and legalese and stuff, and you can't go through it all and completely define and identify all of these areas that you need to be mindful of, and so you just kind of take and pass it off having signatures on both sides, "Okay, we're good to go. File it away. We'll just be really, really careful. We'll mind our business." Why do so many businesses have a problem protecting themselves in this day and age?
Virginia: I think the way you phrase your question really hits the nail on the head. There's a silo mentality. We tend to compartmentalize, and we tend to think, to act, and to deliberate within our own whatever our expertise is. So if your expertise is tax you think of those matters, etc. So the pre-financial crisis mentality was focused squarely on a company or an entity's failure to comply. I'm sure a lot of your listeners have heard of enterprise risk management, and perhaps many of them, in general many organizations have used a traditional form of enterprise risk management. So essentially what enterprise risk management purports to do is to focus on identifying, measuring, and reporting on an organization's top risk. And they tend to the ask experts from the various fields about what their feelings are and what their conclusions are based on the information that is given from their points of view. What the problem is that when you compartmentalize and you have a silo mentality where you do not have an open forum of communication, you do not see what the left hand and what the right hand are doing. You completely miss an entity-threatening risk.
At the beginning of 2013 the National Association of Corporate Directors, they said, “We have a fundamental re-thinking of risk as it pertains to business matters.” So they said that every board and every management member must be certain. It's not a guess, it's not an estimation, but they have to be certain that the risk appetite which is implicit in their company's business model and strategy is appropriate. So risk appetite, you have to fundamentally understand, can our company really go through with whatever endeavor that we have in mind to go forward with? It's not just a guess, it’s not just an estimate, it's do we have the resources necessary, can we carry through with the goal that we have in mind to accomplish?
The next point is that the expected risks are commensurate with the expected rewards. Also, management has to have a system in place to properly manage, monitor, and mitigate risk. And that system is appropriate given the company's business model and strategy. So if we're talking about a company that has domestic business and is in a certain industry, probably having a policy on Foreign Corrupt Practices Act wouldn't be applicable yet, but it depends. If the company wants to expand and go internationally then they have to consider Foreign Corrupt Practices Act in other matters. That is why they're so critical to have open and flowing communication with your experts, be it your general counsel, your attorney, be it the tax attorney, be it your CPA, whatever expert you're working with, that communication line has to be very strong otherwise you cannot make a true decision and you cannot move forward. That communication has to be intact.
And the other point is: the risk management system informs the board and management of the major risks that are facing the company. What that means is, is there's an appropriate culture of risk in the company? That means setting the tone at the top. It's one thing to have a policy on paper, but it's quite a different matter to have the training, to have everybody from the contract manager, to the project manager, to your contract administrator, to your administrative assistant fully engaged and understanding that the processes and policies in place at the company are there to achieve the company's end.
So contract risk management is an essential component of managing legal risk.
Jeff: I'm assuming then, Virginia, that if a company has any issues or if they don't know how to get started, in basically getting kind of that, taking that proactive approach toward ensuring that they are actively protecting it, proactively protecting it by getting out in front of these potential risk management exposures that they could have that they need to contact a business attorney and do that in the early going, is that right?
Virginia: Oh yes. Fundamentally contacting an attorney at the very beginning, so even for a start-up, even before the bare beginning you contact that attorney and it could be that you need help with intellectual property. So you then talk with an attorney who specializes in that. It's akin to if you have a heart condition you go to a heart specialist. You identify, you have to arm yourself with the necessary information, that's the bottom line. And by arming yourself with the necessary information that also includes with whom you consult in finding those experts. People, and usually I've heard that business people, they tend to find these experts be it within their industry, if they go to conferences they tend to know who the experts are. They can find for instance from the local bar association usually will give a list out of attorneys that are involved. But usually what I’ve found from various business people is that they tend to find the experts that they needed to contact from within the industry. So from conferences, or from presentations or workshops, they tend to find those people. And it could also be word of mouth whom they've consulted with. And the role of the attorney, I just want to make this clear, it's to represent the client's interest. Client makes the ultimate decision but attorneys look to see how we as the expert, as the attorney, can serve the client's interest. It's not just solely the problem at the moment. So the attorney is a trusted advisor. As is the CPA, as is whatever other expert you consult with. Law is fundamentally a specialty field, very complex. So as I said before if there are IP, intellectual property issues, you'd want to speak to a specialist in that area especially when we're talking about technology or other matters. Especially if you're thinking about going abroad. A lot of companies that do work internationally, they'll tend to connect with attorneys who are in that country and understand that country's laws. You have to talk to a specialist in those particular areas.
But also I would say that it's incumbent on organizations to understand and to find sources of legal risk. Usually that can be found in contracts, in regulations that are applicable to their industry, to any litigation that has happened in the past, or potential litigations, as well as any changes that the company is thinking of making. And then those sources of legal risk, of course the attorney definitely will be the partner with the business person to find where those risks are and if they cannot be eliminated then mitigate those risks. But as you've highlighted earlier the communication is crucial, otherwise there's just no way to make a proper decision.
Jeff: Well, Virginia with that said and on that note we're going to have to leave things here, but I'd like to let our listeners know where you might be reached in case they have any questions. They might want to sit in on one of your classes or perhaps sign up through UCI extension for your classes perhaps, or just maybe contact you about possibly consulting with them in their particular needs. How can they reach you?
Virginia: Sure. I am one of SBA SCORE’s mentors and I am going to be giving a workshop in January so stay tuned for that. It should be appearing on SCORE's website. The best way is by email. It's email@example.com. And I always laugh when I give my name because I know it has too many vowels in it. The classes that I teach at UCI extension are a great way. I'm also recently become an adjunct professor at Concordia University Irvine for their MBA program. And it's very interesting because the courses that I teach are catered toward professional business people. So take out the legalese and you present the areas of legal consideration for the professional business person. So that's the way I approach my classes. And providing and arming the students and those in attendance with that information will make you a sharper business person in the end.
You identify, you have to arm yourself with the necessary information, that's the bottom line. And by arming yourself with the necessary information that also includes with whom you consult in finding those experts.
Jeff: There you go. And obviously as you just pointed out by taking the legalese out of it you're making it more clear for average folks to kind of understand, and then they can better apply these principles to their own situations and their own companies. Virginia Suveiu it's been a delight to have you on the program today and we hope to have you back on again in the near future. I hope that you’ll entertain that idea and thank you again for joining us.
Virginia: Of course, it was a pleasure, and I look forward to future conversations. It's been wonderful.
Jeff: Virginia Suveiu has been my guest. She's an attorney and also teaches at UCI's extension. And if you need further information on Virginia we'll be happy to pass that along. Simply check out this podcast again and again at morganandwestfield.com.
Deal Talk has been presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one call Morgan & Westfield today at 888-693-7834 or visit morganandwestfield.com. And for more valuable information and insight from our growing list of small business experts make sure to join us again here on Deal Talk. I'm Jeff Allen, thanks again for listening and we'll talk to you again soon.