How to avoid litigation, cut legal costs, and get on with your business
You'd think executives would handle legal disputes with the same rigor they do other aspects of their business. Why do most simply hand their lawyers a blank check, sustaining a fight that will probably never see trial? Especially today, when there are more alternatives to the courtroom than ever before. -- S.D.S.
Perry Mason was fun to watch; after all, you weren't the one up on the witness stand getting scorched on cross-examination. But the reruns might be painful to see. For executives of small companies, litigation has become a not-so-silent business partner.
Once just an unpleasant diversion, litigation is now as much a part of doing business as finance and marketing. And lawsuits come packaged in a hundred different ways: a fired employee sues for wrongful discharge; a competitor charges patent infringement; a consumer claims injury from using your product.
The situation grows worse every year. More than 16 million civil cases were filed in state courts in 1987, 239,000 in federal courts -- one case per every 15 people in the United States. The cost to business is staggering: U.S. companies spend more than $20 billion a year on litigation, not including the cost of settlements and judgments. In individual cases, the typical battle over depositions and documents often lasts for five years and legal fees can exceed $100,000. Many small companies are forced to cover these costs by cutting into budgets earmarked for sales or product development (see "The Case of The Stolen Secrets," page 2).
Lawyers shoulder much of the blame for the expense of litigation. Their economic self-interest may prolong some cases that might otherwise be settled. What's more, few chief executives actively manage their legal disputes; they fail to apply the kind of cost-benefit analysis that lends discipline to other areas of their businesses. Even companies with sophisticated cost controls hand their lawyers what amounts to a blank check.
Aside from depositions, most CEOs involve themselves at only two stages of a dispute: when the suit is filed and when it is close to trial. "Until push comes to shove on the courthouse steps, there is no input from business executives," says John H. Wilkinson, a litigation partner with Donovan Leisure Newton & Irvine, in New York City. "They don't ask the hard questions: what do I stand to win or lose? What numbers would represent a good settlement? There is no analysis until they've spent, in some cases, millions of dollars. But a risk analysis could have been made as effectively before they spent that money as after."
Managing a dispute involves taking a tough stance on legal expenses. A lawyer's search for a smoking gun can cost at least $1,000 for a day of depositions, far more for skirmishes over the release of documents. "Are you going to spend thousands of dollars looking for a document when it's one chance in 500 that it even exists?" asks Wilkinson. "Lawyers keep going without any check from the court or the client."
Managing a dispute can also mean never going to court at all, but settling at an early stage of the litigation process. There have never been so many ways to step outside the legal system to settle a case quickly and inexpensively using alternative dispute resolution (ADR) techniques.
The old warhorses of ADR, arbitration and mediation, still enjoy popular support, but the 1980s have introduced new techniques for settling disputes. Minitrials, for example, bring lawyers and executives together for a one-day argument of the case; most such cases settle soon afterward. Some companies employ their own "rent-a-judge" to hear a case. Even the courts promote ADR. Many federal judges conduct their own summary jury trials (see "The Case of the Slow-Moving Elevator," page 4) or appoint special masters to settle complex cases involving multiple parties.
Given the variety of ADR procedures, only the will to try it may be lacking. Many executives insist on having their day in court. Few, though, ever do. About 95% of all suits settle before trial, often on the courthouse steps. The ADR movement attempts to accelerate the settlement process so that companies can get back to work.
One of the primary advantages of ADR is that the litigants can choose the neutral third party, an important consideration in complex cases. Recently, for instance, litigants in an antitrust dispute selected a former antitrust chief of the U.S. Justice Department to hear their case (see "The Case of the Price-Fixing Cartel," page 3). Litigants can make the proceeding binding or nonbinding, and can set the rules in advance. Private proceedings can also discourage unwanted publicity.
Most executives say an ADR proceeding allows them to see the relative strength of each side's case for the first time. "At this point," says Frank Sander, a Harvard Law School professor, "with the lucid picture they don't get when they talk with their lawyers, they can make a business decision about going ahead with the lawsuit or trying to settle." Catharsis plays a major role, too. "People who feel they've been wronged want their day in court," says Eric D. Green, cofounder of Endispute Inc., a Washington, D.C., dispute-resolution firm. "But it doesn't have to be in court. They just need to lay out what a bastard the other side is before they're ready to settle." In settling, both parties can protect their interests, sometimes using more creative solutions -- a new contract or creative payment methods involving goods or services instead of cash -- than a judge or jury could devise.
No one knows how many lawsuits are settled using ADR, but the number is certainly growing, creating a new industry in the legal trade. In California, Judicial Arbitration & Mediation Services Inc. (JAMS) employs more civil judges than the Los Angeles Superior Court, one of the largest in the country.
Anecdotal evidence points to enormous savings if companies choose ADR early. One survey found that litigants in 31 lawsuits saved a total of $49 million in legal fees by using ADR to settle disputes ranging from relatively simple contract cases to complex antitrust actions. That kind of flexibility makes it likely that the movement will grow. More than 350 companies, many of them from the Fortune 500, have signed a pledge to pursue ADR whenever they become involved in a legal dispute. Small companies appear to use ADR less frequently, probably because few are aware of its advantages.
But old habits die hard. Consider the case of Alan B. Epstein.
Epstein founded Judicate Inc., in Philadelphia, the first (and still only) public company offering dispute-resolution services. Last year his board fired him because of Judicate's poor showing. Epstein filed suit. Judicate offered -- what else? -- to submit the suit to ADR. Epstein made his own offer of ADR.
Neither one, of course, accepted the other's proposal.
The Case of the Stolen Secrets
Defense Technologies Inc. (DTI): A Bedford, Mass., marketer of electronic security systems for corporate jets. Privately owned; largest shareholder is Michael Leavitt. Sales of $1.5 million in fiscal 1988. Shepherd Intelligence Systems Inc.: Competes in the same market as DTI. Private company in Lexington, Mass., with 1988 sales of $1 million. Founded in 1986 by Robert F. Jasse, founder of Chomerics Inc., an Inc. 100 company.
Not much remained of DTI on a Monday morning in December 1985. Only a part-time secretary, to be precise. The rest of the crew, including the president, had walked out, defecting to a competing company started only days earlier by Robert Jasse.
Jasse had negotiated for two months to buy DTI from owner Michael Leavitt. But on December 19 he learned that Leavitt had given someone else a right of first refusal to buy the company. Jasse was furious at what he considered Leavitt's deception. The following day, a Friday, Jasse announced that he would start a competing company. And he resolved to hire anybody who had anything to do with DTI's product. DTI president Michael Forhan quit and joined Jasse the same day. DTI's technician followed. By Monday Jasse had plucked two more employees from Micrologic Inc., DTI's subcontractor, including the chief engineer of the aircraft security system.
Within the space of a few days, DTI had all but ceased to exist. Stunned by Jasse's action, Leavitt fought back. He immediately appointed a consultant, James Bricker, to be the new president. As the new year started, he filed suit against Jasse and his new company, Shepherd Intelligence Systems. He charged Jasse and others with theft of trade secrets and other wrongful acts and charged Forhan with breach of his fiduciary duty as an officer of DTI.
Within months the dispute had escalated into five lawsuits. And the fire they generated began to consume both companies.
Jasse decided to follow the "Pac Man" offense -- consume as many resources as possible in litigation and hope your opponent goes bankrupt before you do. Even the smallest companies use the litigation process itself -- and the enormous sums it takes to sustain it -- as a weapon to punish their opponent.
Remarkably, Shepherd Intelligence did not even have any revenue when Jasse decided to fight a battle of attrition. "Our strategy was to spend $1 for every $2 they spent," says Jasse, "hoping they would reach the breaking point before we did. We knew their burn rate for legal fees was about twice what ours was; sooner or later that would hurt them. We knew how much it was hurting us."
And hurt it did. Jasse says many potential investors walked away when they learned about the lawsuit. Michael Oyer, Shepherd's chief engineer, complains that product development was slowed because $100,000 of Shepherd's funds went to its lawyers.
But Jasse was right -- his opponent, DTI, suffered the most. Each year it spent more than 10% of sales, which reached $1.45 million in 1987, on legal fees; at one point, it fell six figures in debt to its lawyers. But what more could Bricker sacrifice? Already, he had eliminated all spending on sales and marketing; the company couldn't even afford a video or a complete demo model to show to potential customers. Bricker had cut all R&D spending, too.
The companies failed several times in attempts to settle the case. But in mid-1988, as the judge began talking for the first time about a trial date, they reconsidered. Even Jasse was somewhat repentant by then. "The expense was preposterous," he says. "The trial would have cost $100,000."
By coincidence, Bo Foster had joined Shepherd Intelligence as its chief financial officer a few months earlier. Foster, who had worked with Jasse at Chomerics for 15 years, had recently been head of Duke University's Private Adjudication Center, which provides ADR services and research. Foster convinced Jasse to try settling again; he immediately called a professional acquaintance, Eric Green, cofounder of Endispute Inc., a dispute-resolution firm.
Exhausted by their fight, the litigants agreed to a minitrial set up by Green.
Jasse remembers sitting with the other litigants just before the start of the minitrial. "How would this thing end in anything but a brawl?" he asked himself. "We were all like a bunch of sailors spoiling for a fight."
The minitrial isn't a trial at all. Essentially, it's an innovative form of mediation. The lawyers argue the case in the presence of the companies' senior executives; the third-party neutral then advises each side of the strengths and weaknesses of the case and tries to coax them into a settlement.
In the Shepherd-DTI case, the presentations inflamed passions all over again. But for the first time in three years, the executives could intelligently assess the risks of a trial. Neither side had an overwhelmingly strong case; each faced a significant chance of losing, with uncertain monetary damages as well.
Negotiations went slowly until Green's colleague, Antonia Chayes, found a way to penetrate Jasse's tough shell. A former undersecretary of the United States Air Force, she capitalized on Jasse's respect for her experience. "One of Jasse's goals was to become a major supplier to the air force," says Green. "Toni told him, 'You know these air-force types -- even the hint of trouble will send them away. The last thing you need is a theft-of-secrets case.' "
Negotiations continued for two months. Finally, on January 10, The New York Times reported that the two companies had decided to merge; Shepherd Intelligence would acquire all shares of DTI. "The deal ends a legal dispute between the two companies," the item said -- a bloodless summary that captured none of the angry battles of three years' duration.
What They Saved
Each company saved at least $100,000 in legal fees. A trial was probably six months to several years away -- on top of the three years they had already waited.
The Case of the Price-Fixing Cartel
Financial Interchange Inc. (FII): A nonprofit corporation with a membership of more than 1,600 financial institutions in Texas and adjoining states. A significant portion of the members are small banks, savings and loans, and credit unions. FII's sole purpose is to operate Pulse, one of the largest consumer networks of electronic funds transfer (EFT) machines, including automatic-teller machines (ATMs), in the country. First Texas Savings Association: One of the largest S&Ls in Texas and a subsidiary of First Texas Financial Corp. In March 1988 First Texas was the largest operator within Pulse, owning 862 of the network's 4,500 ATMs.
First Texas Savings Association was in trouble. Its financial condition was deteriorating rapidly. Then came another blow, and this one was too much to take without a fight.
Through the summer of 1987, the 16-member Pulse board considered a major change in the ATM network's fee structure. A bank whose customer used another bank's ATM would pay a fee to that bank for the transaction; the new structure would lower the payment on cash withdrawals. Banks that owned few or no ATMs -- most small financial institutions fit this description -- stood to save money. On the other hand, a big ATM owner such as First Texas figured that at least a couple million dollars in revenues would evaporate each year.
First Texas warned Pulse that the proposed fee changes would violate federal antitrust laws; the Pulse members, First Texas charged, comprised an illegal buying cartel that fixed prices. "I always said, 'You can't do it, you can't do it,' " says Scott Engle, a former Pulse board member and then head of the First Texas ATM network. "I warned that First Texas would probably sue if the changes were adopted. I said there was too much money at stake and that we had a good case.
"There was a lot of animosity," Engle continues, "especially near the end when it looked like we would sue." In October the board approved the change over Engle's strong dissent. Pulse braced itself for the lawsuit.
First Texas, though, never arrived at the courthouse. Pulse attorney Donald Baker, a partner with Sutherland, Asbill & Brennan, in Washington, D.C., proposed that the parties try binding arbitration instead.
The advantages of arbitration were impossible to ignore. Baker had headed the antitrust division of the U.S. Department of Justice from 1976 to 1977, and he understood that an antitrust suit could tie up the parties for years. "A couple years in Texas banking is a long time," Baker says dryly. Worse still, the acrimony would imperil any continuing business relationship between the two. "We'd emerge with a better relationship with Pulse if we used arbitration than we would if we went to court," Engle says.
Arbitration would also save money. Because of the complexity of antitrust cases, each party could expect to pay at least $3 million in legal fees over the life of the case -- a sum neither could afford. First Texas was close to insolvency; nonprofit Pulse would have had to assess its members to pay the lawyers' bills, which could easily reach $100,000 a month. With arbitration, though, they would have only a few months, not years, to prepare their cases.
What sealed the decision in favor of arbitration was being able to choose the neutral. If antitrust law was complicated, then trying to apply it to a technically and financially complex area such as ATMs was truly intimidating. "It was better to rely on an antitrust expert than a jury or even a judge unschooled in antitrust law," says Robert M. Cohan, an attorney for First Texas and a partner in Cohan, Simpson, Cowlishaw, Aranza & Wulff, in Dallas.
The two sides signed the arbitration agreement on March 23, 1988, and easily agreed on the arbitrator -- Thomas E. Kauper, Baker's predecessor as antitrust chief at the Department of Justice. And they agreed to a cap on the amount Pulse would pay First Texas if Kauper declared the fee agreement illegal and if he found that First Texas suffered damages because of it.
The short preparation time, 70 days, forced both sides to discipline their approach to gathering information. When the final seconds ticked off the clock, they had filed some 30 depositions and 116 exhibits with Kauper, just a fraction of the discovery that would have taken place in typical litigation.
Kauper read the material and told the attorneys which of the witnesses he wanted to appear at the hearing. On May 31 Kauper called the hearing to order. Over the next five days, he conducted a proceeding that Cohan describes as "the most enjoyable time I've had as a litigator."
What distinguished the hearing was Kauper's command of the subject. "It was a no-B.S. environment," says Baker. "You couldn't pretend that something irrelevant was relevant or that some obscure principle of antitrust law would solve everything." A procedural innovation also sped things up. Instead of calling witnesses serially, Kauper had both sides testify simultaneously on the same issue, letting him see their differences quickly so he could try to reconcile them.
On June 20 Kauper issued a final order to the parties. Pulse's fixed fees violated the antitrust laws, he said, and he suggested that the organization convert to a flexible fee system. He awarded no damages. Two months later Kauper released an 84-page opinion.
For First Texas, victory was bittersweet. What had teetered in the spring toppled in the fall. The FSLIC took the bank into receivership, selling it to Ronald Perelman, CEO of The Revlon Group Inc. In its second life, it is known as First Gibraltar Bank FSB.
What They Saved
Stan Paur, president and CEO of Pulse, estimates that his legal bills were only about 20% of what they would have been in conventional litigation. And the proceeding saved the company much disruption. "We only had 13 employees," he says. "Three or 4 were pulled off daily to prepare for the proceeding. We were in a damage-control mode for months -- but fortunately, only months as opposed to three years or so if it had gone through litigation."
The Case of the Slow-Moving Elevator
Trebmal Construction Inc.: A construction and real-estate development company with headquarters in Cleveland. Headed by Carl Milstein, who founded the company in 1974. Annual sales from $5 million to $15 million. Dover Elevator Co.: A subsidiary of Dover Corp., a Fortune 500 elevator manufacturer with 1988 sales of $1.95 billion.
Carl Milstein was one of the few people betting on Cleveland's future back in 1979. His company, Trebmal Construction, bought an old downtown hotel and began renovations to convert it into an office building. Milstein contracted in 1980 with Dover Elevator to bring the elevator system up to date with the rest of the building.
Dover installed four new elevators, but problems arose immediately. The elevators, Trebmal complained, did not move people quickly enough -- and the building had reached only half its occupancy. Trebmal filed suit in federal court in September 1983, complaining that Dover had breached the contract and its express and implied warranties that the elevators were fit for the particular purpose for which they were intended. It asked for more than $1 million in damages. Dover denied any liability.
From the beginning, it looked like fighting between the two companies' attorneys would add greatly to the difficulty of settling the case. As the discovery process began, tempers flared. Responding to one request for documents, Dover searched through files in several cities for 10 months and failed to come up with what Trebmal wanted. Trebmal's attorney asked U.S. District Judge Thomas D. Lambros to impose sanctions for "a cavalier and incomplete response . . . [that] must be treated as a total failure to answer." Time and again, the lawyers lashed out at each other. They fought on -- for five years.
Judge Lambros was fed up. Back in 1980 two nagging cases like the Trebmal-Dover suit had consumed weeks of his courtroom time. "These two were cases that could have been settled," says Lambros, "but something was missing in the pro-cess. There was an information gap, an inability of counsel and the parties to effectively predict how a jury would see it."
After those cases, Lambros devised a new proceeding he called a summary jury trial. The lawyers argue to a jury for one hour in the presence of their clients. The jury returns a verdict on liability and damages, usually the same day; the lawyers then ask the jurors individually how they reached their decision. The verdict is only advisory, but "clients see that once they enter the courtroom, they've transferred the decisional process to the jury," says Lambros. "It brings home the reality of the trial and the risk of losing." Lambros found that more than 80% of all cases that went through summary jury trial -- and he reserved the technique only for "hard-core durable cases" -- settled before the real trial. In 1984 the Judicial Conference of the United States recommended that all federal judges consider using the technique, and today dozens of them do.
The judge scheduled the Trebmal case for summary jury trial on May 16, 1989, only four months short of its sixth anniversary in litigation. Clearly, Lambros did not want to spend a week trying the suit, an unremarkable case that he felt the parties could better resolve themselves. The litigants had a right to a jury trial, of course, but Lambros saw the federal courts as a limited resource that should be used more wisely.
On the day of the proceeding, only minutes passed before the sniping started. José Feliciano, of Baker & Hostetler, the attorney for Dover, argued that evidence of Milstein's prior conviction on two federal felony charges should be admissible at trial. "If you want to try that monkey business, go ahead," William J. Kraus, of Kraus & Kraus, the attorney for Trebmal and Milstein, replied angrily. As the two went at each other, Lambros interrupted: "I'm not really interested in your egos at this point."
The admissibility question was an important issue, though, and the flexibility of the summary jury trial enabled Lambros to handle it in an innovative way. He announced that he would empanel two juries of six people each. Both juries would sit through the presentation and hear the judge's charge; then, while the first jury retired to consider the evidence, the second jury would stay to hear the additional evidence of Milstein's prior record. By questioning the jurors later, the attorneys could see if the evidence made any difference to the case.
The summary jury trial began as both lawyers presented a synopsis of their case to the juries, who would not know until the end of the day that their verdicts were nonbinding. Also in the courtroom were two executives with authority to settle the case, Trebmal's Milstein and Dover's regional manager Thomas McManus.
After the juries began deliberations, yet another row broke out between the attorneys. Feliciano gave the jurors some documents; Kraus, as he had done before, accused him of not getting approval in advance. Angry words were exchanged. Feliciano took a step toward Kraus; Lambros flew off the bench and ordered Feliciano to sit down, then threatened to call a federal marshal. "I didn't want Feliciano to give Kraus a heart attack," Lambros said later.
The tension only grew as first one and then the other jury reported their verdict. The first jury ruled for the defendant, Dover. As the jurors were questioned, it became clear why. In essence, they felt that Trebmal was a sophisticated company that had chosen a relatively inexpensive elevator system and should therefore have to live with the consequences.
Then the second jury came in: another finding for Dover.
Most cases settle shortly after the summary jury trial, but not this one. Lambros set the real trial for the second half of September.
In June, Kraus prepared a settlement offer, which in August had not been accepted. He complained that the summary jury trial didn't give him enough time to set out his argument -- a peculiar assertion, since his suit is a relatively simple contract case, and summary jury trials have brought settlements to such enormously complex disputes as toxic pollution cases.
Judge Lambros remains stubbornly optimistic. "They are heading to trial with a sense of reality about their cases," he says. "And for the first time, they are in a settlement mode."
THE ANATOMY OF A DISPUTE
January 1, 1988
Include clause in contract for alternative-dispute resolution (ADR) technique.
March 15, 1988
September 10, 1988
Top executives should discuss litigation versus ADR. Would litigation be cost-effective? Calculate legal expenses, management time, loss of ongoing business relationship.
January 1, 1989
Make sure you and your attorney are familiar with ADR. Propose use of ADR to other party.
($10,000 spent to date)
April 1, 1989
The discovery process, which includes depositions, interrogatories, and production of documents, can be very time-consuming. Given the increasing litigation costs, is it wise to continue? An early settlement saves you lots of money. Your lawyer should keep you appraised of the risks and rewards of proceeding with the litigation, as well as your potential legal bill.
($110,000 spent to date)
Judge Sets Trial Date
September 1, 1993
Last chance to assess litigation's risks and rewards and find a businesslike solution.
($135,000 spent to date)
January 1, 1994
If you've gotten this far, you either have irreconcilable differences with the opposing party, or you haven't managed the dispute very well. Probably the latter.
($175,000 spent by end of trial)
ACT NOW, SAVE LATER
Building alternative dispute resolution into your contracts
It can be difficult in the heat of battle to convince the other side to use alternative dispute resolution methods. For your best chance at avoiding costly litigation, you should write an ADR clause into all your contracts from the beginning.
There are many different ADR techniques, but an ADR method chosen in advance may not be suitable for the type of dispute that eventually arises. Consider providing for a third-party neutral to intervene if you and your associate reach an impasse, reserving choice of the exact forum and rules for future negotiation.
John H. Wilkinson, a litigation partner at Donovan Leisure Newton & Irvine, in New York City, recommends that companies include the following provisions in ADR contract clauses:
* There will be a period of negotiation before the start of formal ADR. Specify which executives will conduct the negotiations. Although ADR is much less expensive than full-scale litigation, you may be able to avoid ADR as well.
* A third-party neutral will be appointed to resolve differences that arise in planning the ADR proceeding. If the opponents cannot agree on a neutral, an organization such as the American Arbitration Association, based in New York City, will appoint one.
* The parties will choose the form of ADR to use, the rules and format of the proceeding, and the extent of fact-finding before the proceeding begins. If they fail to agree on any of these points, the neutral will decide.
* The parties will agree that the proceedings will be confidential and will be used for no other purpose.
* Either side may initiate a lawsuit if settlement is not reached within a specified time after the start of ADR.
If your lawyer is unfamiliar with ADR, you can get general information as well as referrals from the Center for Public Resources, in New York City, or the American Bar Association, in Washington, D.C. Don't be surprised if your lawyer frowns on ADR; after all, a protracted court case means more money for your counsel.