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Taking On The Tort Tax

A Chief Executive survey on litigation elicited responses from more than 800 CEOs, CFOs, corporate attorneys, and plaintiff lawyers. The consensus: Booming liability costs are pushing up the prices of products and services. You lose, and so do your customers.

How long has it been since your company was sued? Not long, probably, unless you’re very lucky-and very diligent.

But what are the odds? To answer this and other questions about the dimensions and effects of litigation against U.S. companies, Chief Executive and Deloitte & Touche LLP asked you to fill out and return a questionnaire that came with CE’s May 1994 issue. Some 785 of you responded, from companies in businesses such as insurance and other financial services, aerospace, chemicals, construction, electrical machinery, forest products, motor vehicles, petroleum, publishing, communications, consulting, utilities, agribusiness, fabricated products, pharmaceuticals, and transportation. See Figure IV for sales breakdown.

Meanwhile, 78 CFOs and general counsel of Fortune 1000 companies replied to the same questionnaire, which they received by mail. And for a different angle on the same issues, we obtained responses from eight prominent plaintiff attorneys on counterpart questionnaires.

First, we asked whether your company had been sued recently. We found that of all respondent companies with revenues under $50 million, 55 percent have been sued in the past five years. Of companies with revenues between $50 million and $500 million, 67 percent have been sued. And of companies with revenues over $500 million, 77 percent have been sued.

Seems odd, doesn’t it? A tenfold difference in the size of the target brings only a 22 percent difference in the probability of getting hit with a lawsuit. But that’s what the data show. The survey also unearthed other findings that we believe will either surprise you or confirm your suspicions.

SETTLING DOWN

Of the CEOs who said their companies had been sued in the past five years, most (85 percent) estimated the average annual amount paid in settlements and judgments at less than $1 million. Naturally, large companies pay more than small ones. Fifty-one percent of companies with revenues over $500 million pay $1 million or more a year, while only 6 percent of companies with revenues under $50 million pay this much.

But the cost of settlements and judgments is not proportional to sales. Smaller companies actually pay a greater percentage of their sales. The cost of settlements and judgments exceeds 3 percent of sales for 23 percent of the smallest companies. But that 3 percent only applies to 4 percent of the largest ones.

Why does the “tort tax” hit small companies especially hard? Perhaps because small companies tend to have gone public more recently than large ones. A recent National Venture Capital Association study found that 62 percent of companies that went public in 1986 have since been sued for alleged securities fraud.

A certain portion of the amounts companies pay in settlements and judgments goes to the plaintiff attorneys who file and either settle or win the suits. The plaintiff attorneys who responded to the survey said that, on average, their fees were less than 50 percent of the principal amount. One said that fees averaged between 10 percent and 19 percent, another said the figure ranged from 20 percent to 29 percent. Two others estimated 30 percent to 39 percent.

The plaintiff attorneys had no reservations about the suits they filed against companies; five said 100 percent of such suits had merit.

By contrast, of the CEOs who said their companies had been sued, 56 percent expressed an opinion on the merit of the suits brought against them: Only 38 percent of them said that at least 20 percent of the suits had any merit, while 49 percent of the CFOs and general counsel mentioned the same figure.

DAMAGE CONTROL

Aside from litigation’s direct costs, doing business in a country that allows, and in some ways even encourages, people to claim damages on dubious grounds creates many different costs, including that of lost opportunity. Ninety-seven percent of the respondent CEOs indicated that they have taken one or more of the actions listed in Figure II to reduce liability or potential liability.

CEOs take the most far-reaching actions with the greatest reluctance. Yet 7 percent of them said they have closed an entire division or subsidiary as a result of a lawsuit. Fifteen percent said they have removed a successful product from the market to reduce liability or potential liability, while 21 percent have withheld financial information that would have been helpful to investors, and 25 percent have changed a product for the worse.

Respondent CFOs and general counsel said their companies had taken similar actions, though not by the same percentages. The CFO-general counsel sample was much smaller than the CEO sample, and on average, represented larger companies. Nonetheless, it is interesting that 30 percent of the CFOs and general counsel said their companies have withheld financial information or forecasts that would have been helpful to investors, while only 21 percent of the CEOs said this. We worded the question to specify financial information or forecasts that were not legally required. Our findings are supported and, indeed, amplified by a recent American Stock Exchange study, which reported that 75 percent of corporate CEOs limit the information given to investors for fear of meritless lawsuits resulting from wider disclosure.

CONSUMERS PAY THE PRICE

Nearly three-quarters of the respondent CEOs said potential liability costs increase the price of their products or services. Of the CEOs who made this statement, 88 percent estimated the amount of the increases.

As a rough yardstick of potential liability costs, it is noteworthy that almost half (48 percent) the CEOs who estimated the increase in the price of their products or services because of potential liability said the increase was greater than 5 percent.

Respondent CFOs and general counsel agreed. Of those who estimated the price increase, 51 percent said it was greater than 5 percent. Half the plaintiff attorneys disagreed, saying they do not believe that potential liability costs increase prices at all.

COSTS OF RISK PROTECTION S

uch costs partly overlap the costs of potential liability. For example, both categories include unwarranted packaging and redundant personnel. But risk protection also entails such costs as internal and external legal services and litigation insurance.

Eighty-two percent of respondent CEOs estimated how much the cost of risk protection adds to the price of their products or services.

Once again, the respondent CFOs and general counsel agreed with the CEOs. Thirty-two percent of the CEOs who estimated the percent added by risk protection to the cost of their goods or services put the figure at 10 percent or more, as did 35 percent of the CFOs and general counsel who gave this estimate.

Rates of change in the cost of risk protection exceeding 9 percent were cited by 56 percent of service company CEOs and 54 percent of financial services CEOs, but by only 29 percent of consumer products CEOs.

SEEKING TORT REFORM

The costs of litigation, potential liability, and risk protection all depend on a country’s tort laws. Do U.S. laws hamper the nation’s companies in global competition? If so, what ought to be done about it?

We asked CEOs, CFOs, and general counsel if they agreed with the following statement: “The U.S. legal system (as it pertains to tort liability) puts U.S. businesses at a disadvantage in their efforts to compete globally.” Over 95 percent of them agreed either strongly or slightly.

Of the eight respondent plaintiff attorneys, two slightly agreed that tort liability hampers U.S. companies in global competition, and six strongly disagreed. The plaintiff attorneys split the same way again on a weaker statement: “Some industries are affected by U.S. tort laws more than others, which may affect their ability to compete globally.”

Over 90 percent of the CEOs said either that it was extremely important or very important for Congress to address the subject of tort reform. Yet only 35 percent of their companies have lobbied or contributed to a lobbying effort for tort reform.

Ninety-four percent of the respondent CFOs and general counsel said either that it was extremely important or very important for Congress to address the subject of tort reform. Probably because they represent larger companies on average than the CEOs, 61 percent of their companies have lobbied or contributed to a lobbying effort for tort reform.

CEOs, CFOs, and general counsel were asked to write in one or more specific areas in which they would most like to see tort reform, and 78 percent of them did.

The CEOs, CFOs, and general counsel also were asked: “If Congress adopted a tort reform package that addressed, to your satisfaction, the areas you mentioned above, what impact do you think it would have on your firm’s profits?” Seventy-three percent of the CEOs and 56 percent of the CFOs and general counsel said it would have either a great impact or a moderate impact.

The respondent plaintiff attorneys saw little need for tort reform, but most of them thought it would have some impact on corporate profits. They also were asked if they thought tort reform would have any impact on consumers, and most of them said yes.

Clearly, the scope and frequency of litigation are expanding. If you’re like most CEOs, you’re jittery but taking action to protect yourself. Regrettably, the costs of such protection are trickling through to the price of products and services. Your customer loses-and, of course, .so do you.

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