Top Ten Mistakes Made By Small Businesses

Scott Bonder was invited to speak at a meeting of the The National Association of Asian American Professionals.  The topic was “The Top Ten Mistakes Made By Entrepeneurs.”    The paper Scott provided follows:

Ten Common Mistakes

A Very Basic Outline Of Issues To Remember

 By Scott L. Bonder, Esq.

 

Fried & Bonder LLC

Promenade II, Suite 3750

1230 Peachtree Street, N.E.

Atlanta, Georgia 30309

(404) 995-8808

 

 

          New businesses are dynamic, and fast paced ventures.  As a result, new business owners are often forced to compromise on where they devote their limited time and attention.  This paper will address some of the more prevalent themes that lead to litigation.  The purpose of using these thematic examples is to introduce concepts that may trigger warning bells should you be faced with a similar situation.   

 

1.Contracts Happen and Grammar Matters

In virtually all businesses, contracts are created and relied upon regularly.  Generally speaking, a contract is an agreement between two or more parties for the doing or not doing of some specified thing.[1]  In most circumstances, a contract can be either written or oral. 

Often, contracts are surrounded by pomp and circumstance forcing the parties to focus on the terms carefully.  For example, contracts to buy houses, new office space leases, and the purchase or lease of vehicles are all event type contracts in which the process is itself  an event. 

Everyday dealings often create contracts that are also binding. For example, if you own a mechanics shop, every time a customer drops off a car for repair, and agrees to a price, a contract is formed.   Similarly, every time an IT service person is presented with a problem and agrees to fix it at a certain rate, a contract is also formed.

Considering the specific terms of every contract is critical to avoiding litigation.  Also, forethought into how disputes will be resolved can make litigation much easier and the outcome more favorable.   For example, if you provide a service that can be rendered remotely, whether by computer or telephone, and your client base is national, consider a choice of law and venue provision.  Without these, you could find that another state’s law applies and that you need to hire a lawyer in another state to enforce your rights.  Also, inclusion of an attorney’s fees provision can make litigation more affordable in the long run.

Another often overlooked area of contracts is grammar.  When a dispute arises, the parties will inevitably turn to the language of the contract and interpret the language in the manner most helpful to their interest.  If the dispute progresses to litigation, a judge will eventually have to interpret the language and will rely on, among other things, grammar.

For example, in an actual case, the entire $12 million dispute was determined by the “that/which” rule.  At issue was whether certain trucks and equipment were considered collateral under a financing agreement.  The agreement described the categories of collateral “which” were in the warehouse.   At the time the agreement was signed, there was only one warehouse.   By the time of the dispute, the defendant had three warehouses with far more trucks and equipment.

Unable to resolve the matter, the case was litigated and the witnesses for each side directly contradicted each other as to what was intended by the collateral provision.  The judge was forced to interpret the contract decided the case based on the “that/which” rule (“which” is descriptive, and “that” is restrictive).  The parties’ use of “which” was deemed to be a mere description of where collateral was at the time the contract was signed.  Had the parties used “that” then the trucks and equipment in warehouses two and three would have been excluded.

Paying close attention to the details, even those you think unlikely to matter, is well worth your time.

 

2. “Best Efforts” Is Worst Practice

Best efforts does not mean performing to perfection.  To the contrary, it means that the party has used reasonable diligence and good faith in performing the task at hand.[2]  The determination of whether a party used reasonable diligence and good faith is subjective.  In other words, the actual party’s actions will be considered as opposed to a legal fiction such as a “reasonable person” in the same position as the real party. 

          The meaning of “reasonable diligence” and “good faith” will probably be very different between the parties.  The person who contracts with somebody who will perform likely has in mind that the performing party will make the project the single highest priority.  The performing party probably thinks that they will do their honest best given the other work they have to do to make a living.  These views are generally not compatible.

          As with so many other areas of contracts, evidence will be the key to enforcing or defending a suit on a best effort contract.  The need for extrinsic[3] evidence, however, can and should be minimized by the contract terms itself.  A clause by which the non-performing party acknowledges other obligations of the performing party can be helpful.  Also, a specific designation of time to completion, allocation of resources, etc., can narrow the issues in dispute significantly.

 

3. Friends Belong On Facebook

This topic is not based in case law or statutes, but rather on experience.  The nastiest and hardest fought litigation, the most disgruntled litigants, and the highest legal fees can usually be found in a disputed divorce.  Business divorce is often worse than marital divorce and more costly. 

Regardless of how long, how well, or the particular nature of a relationship, partners, associates, shareholders, and alike are business dealings.  Every transaction should be in writing.  Every contingency should be included in the business documents.  Literally, everything that can be thought of must be in the documents and negotiated as a business decision to avoid overly hard feelings in the future. 

Fights over furniture, art, customer good will, and client origination can quickly degenerate into litigation if the parties did not agree in advance on a process for the departure of an associate or dissolution of a business.  But, if these matters are handled before a dispute while the promise and excitement of a new venture still exists, they are fairly easy to work out.

You may become friends with your business partners.  You can become business partners with your friends.  But, when discussing business there are no friends.

 4. Industry Standards Are Guidelines At Best

Industry standards, under certain circumstances, may be implied as part of a contract provided that the contract itself does not specifically contradict that industry standard.[4]  For an industry standard to be considered a part of a contract by a court, that “standard” must be of “such universal practice as to justify the conclusion that it became, by implication, a part of the contract.”[5]  Such standards may resolve ambiguities in a contract.[6]  But, where a document is so deficient as to not include all the essential elements of a contract, industry standards may not be inserted to create one.[7]  To be useable, a custom must be well known, certain, uniform, reasonable, and not contrary to existing law.[8]

          The first notable hurdle in using an industry standard is to prove the existence of such an industry standard, which in a relatively new industry can be extremely difficult.  Also, unless the standard is so well known in all of its facets that it cannot be disputed, then the reliance on an industry standard is an invitation to litigation. 

In some truly ancient industries like shipping, insurance, or lumber grading, standards are tantamount to law.  In fact, they are often so powerful because they were law under the old English guild system or part of a business given the stamp of approval by the government.  For example, assignment of liability for risk loss created by the ancestors of today’s insurance industry such as Lloyd’s of London, began as early as 1688.[9]

Never rely on an industry standard.  Instead, incorporate it into your written document.  If it is truly standard, then nobody will object and you will be protected.

 5. Oral Contracts Are Not Worth The Paper They Are Written On

While not always accurate, it is wise to heed the old saying that “an oral contract is only as good as the paper it is written on.”  The availability of evidence to prove the contract will ultimately determine if the old saying is true in a particular case. 

Proof of a contract necessarily involves the “elements” of the alleged contract.  The essential elements of any contract include capacity to contract, consideration, mutual assent, and valid subject matter.  While certain contracts must be in writing, they are of a type generally beyond the scope of this presentation.[10]

Evidence of contract elements may be in virtually any common form such as a written and signed contract (the best), unsigned written contract on which the parties performed (a step down), letters/emails/faxes (another big step down), voicemails (worse yet), or witness testimony (terrible). 

 6. Written Contracts Really Do Mean What They Say

This topic may seem redundant, but experience demonstrates that the point requires more emphasis.  A contract really means what it says and it can and likely will be enforced based on its express language.  Once a dispute arises, parties are very rarely able to modify or vary from the express terms of the actual contract.

Excuses that have NOT worked in the past: “But we talked about changing the volume.” “She okayed the change of color.”  “The parties met over lunch, talked, and they suggested the delay.”

 7. Corporate Formalities Are Not Optional

The basic purpose for a corporation is to insulate the business owner from liability for corporate acts.  Luckily, the law has developed so that a corporation is a legal person.  The critical elements to maintaining a corporation are its formalities such as bylaws, meetings, minutes, and votes.  As long as a corporation remains a person, then the shareholders, officers, and directors are insulated from most liability.

Problems arise, particularly with small companies, when the formalities are not maintained.  A more serious risk to corporate insulation arises when the owner treats the company like an alter ego.  Comingling funds, using a company car for personal travel, running household expenses through corporate accounts are all acts that can result in a waiver of corporate insulation.

Litigators look for any flaw in the corporate form to use as leverage.  Corporate flaws usually lead to a claim of “piercing the corporate veil,” which means that the other party is trying to bypass the company and get to your personal assets.  Although you cannot avoid such a claim being made in a lawsuit, you can defend against it by constant vigilance during the life of the corporation.  Paying close attention to the corporate formalities and maintaining its separateness is the best defense.

 8. Lack of Insurance Assures A Claim

In surveying litigators for this paper, the lack of insurance appeared to be the most frustrating.  Almost all responses concerning insurance expressed that the litigation would have likely been avoided if insurance existed.  Even in those cases where litigation would not have been avoided, litigation defense would have kept the business from bearing the extreme expense associated with litigation.

 

 9. Address Potential Difficult Issues Early

People naturally seek to avoid conflict.  As a result, business people and salespeople often either avoid difficult topics or try to address them in some vague way.  Either method leads the parties to think that their view on the avoided topic is the operative view.  Rarely, once a dispute arises, do the parties share a view on a disputed topic.

Addressing the difficult topics head on may seem like a mistake.  Indeed, addressing them may kill a sale.  So, you should, at the very least, actively do a risk/benefit analysis to determine whether to address the difficult issue. 

As a general rule, when dealing with difficult topics internally such as with partners, the risk is too high and there is virtually no benefit.  (see III and V above).  Whether there is ever enough benefit to justify avoiding a difficult topic is purely your decision, but I suggest that the risk will always be too great.

10. Employment Relationships Are Relationships That Matter

Employees are the face of your company, the backbone of your ability to leverage time and resources, and a huge potential source of liability.  As an initial matter, employment relationships are contractual in nature.  Accordingly, all of the contract related suggestions above are applicable.  Second, employees often trigger a number of statutory and regulatory requirements that you must be familiar with at all times.  Finally, managing employees, generating loyalty, and preventing law suits is a skill well worth developing.

a.  Employment Contracts

Written employment contracts are a great idea.  The can set out the scope of employment, limit authority, and generally clarify all of the duties you expect the employee to carry out.  Employment contracts can also relieve you of responsibility for a wide variety of duties such as monitoring the employees hours, and investigating the work environment prior to complaints.

Written employment agreements often also limit an employee’s right to sue, and may require arbitration.  Non-competition agreements, non-solicitation agreements, and anti-piracy provisions are also often found in express employment agreements.  None of these protections for the employer will exist without a written contract.

b.  Statutory and Regulatory Issues

Depending on the number of employees, your company may be subject to federal laws against discrimination in the workplace.  Discrimination in the workplace is a specialized area of law for which you should seek assistance before an issue arises.

For example, by consulting with an employment lawyer you can avoid inadvertent age or disability discrimination.  Also, an employment lawyer can help you put in place a mandatory reporting scheme for employees to follow should they have a complaint.  Failure to follow these procures can actually prevent an employee from filing a claim with the EEOC or filing a lawsuit.

          Another area of law that often causes problems for employers is the difference between management/professionals and employees.  Basically, employees must be paid overtime and management/professionals are exempt from overtime rules.  If a management/professional type successfully challenges their designation, the remedy can be harsh. 

Generally, that person’s salary is divided down to determine an hourly rate and they are then paid overtime going back as far as the law allows.  Worse yet, if that management/professional person is just 1 of a larger group, then all members of that group have to be re-designated and paid back overtime.  Consultation with an employment lawyer periodically can help avoid these errors.

c. Managing Employees

Managing employees to get the most out of them is a skill that not all people posses.  Nevertheless, open and frequent professional communication with employees will go a long way to making up for any lack of inherent skill.  Moreover, open and frequent professional communication will help avoid lawsuits.

Maintaining complete and accurate employee files is also critical.  Document all discipline.  Document all extra days off.  Document everything so that there is no dispute about it in the future.  Generally, undocumented events are worse for the employer than the employee.

 

         

 

 

 

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[1] O.C.G.A. § 13-1-1. (Using Georgia law as an example, but the law of the various states may differ.) 

[2] See, e.g., Jackson Electric Membership Corp. v. Georgia Power Co., et al., 257 Ga. 772, 364 S.E.2d 556 (1988); Flynn, et al. v. Gold Kist, Inc., 181 Ga. App. 637, 353 S.E.2d 537 (1987).

[3] Extrinsic evidence is the legal term for evidence outside the contract or writing at issue.

[4] See O.C.G.A. § 13-2-2(3).

[5] See O.C.G.A. § 13-2-2(3).

[6] Colonial Pipeline Co. v. Robert W. Hunt Co., 164 Ga. App. 91, 296 S.E.2d 633 (1982).

[7] Newark Fire Ins. Co. v. Smith, 176 Ga. 91, 167 S.E. 79 (1932).

[8] American Mut. Liab. Ins. Co. v. Curry, 187 Ga. 342, 200 S.E. 150 (1938).

[9] Lloyd’s of London actually started as a coffee house.  Ships’ captains and merchants gathered there to discuss the risks associated with each ship and its cargo.  They divided the risk and signed a document evidencing the arrangement.  Their signatures appeared underneath the description of the ship and cargo.  Hence, they became known as underwriters.  This practice developed into the modern insurance industry, which was formalized by the Lloyd’s Act of 1871 in England.  Insurance as a concept, however, dates back as far as the Code of Hammurabi.

[10] O.C.G.A. §§ 13-5-30, 13-5-31 (contracts that cannot be performed within one year, and others)