A multimillion-dollar Florida electronics manufacturer last year suffered a 10% drop in net income despite higher sales and higher gross profits. A lengthy patent dispute with one of the industry giants had saddled the small company with huge legal fees, besides creating a substantial drain on management's time.

The case dragged on for more than a year before the small manufacturer realized it was no match for its competitor's superior legal and financial resources. It finally agreed to fairly stiff settlement terms, including a provision that required it to pay the larger company $700,000.

The manufacturer's losses were unnecessary, and they illustrate how important it is to resolve conflicts before they escalate into long, drawn-out court battles. With good strategy and creative thinking, such battles can be avoided, first, by using dispute-prevention techniques to keep ordinary business problems from becoming legal fights, and then, if a dispute does arise, by using resolution techniques to keep the problem out of court.

Both methods are especially necessary for small companies that don't have the high profit margins or extensive management resources necessary for costly litigation. The purpose of both these tools is to keep control of business disputes in the hands of management so that the solution is quick and cheap.

PREVENTION. In business, as in health, prevention is the first line of defense. One way to ensure prevention is to insert provisions into a business contract that will head off a problem before it escalates into a legal dispute.

Tripwire provisions. Too often, a problem is first evident when a complaint is served in a lawsuit. A "tripwire" can avoid this surprise. For example, the contract between a company and its supplier might require each party to give 30 or 60 days' notice of a dispute before going to court. Better yet, it can require that the notice contain a concise statement of the grievance, a recommended solution, and a fixed time for the other side's response. At the very least, this type of provision imposes on both sides a mandatory cooling-off period before one or the other succumbs to the emotional impulse to sue.

A tripwire clause recently prevented litigation between a small Midwest distributor of consumer products and a large West Coast manufacturer. The bigger California company threatened to sue the distributor for failing to meet contractual sales quotas and for refusing to conduct an expensive local advertising campaign for the manufacturer's products. In addition, the distributor had added a line of household appliances that offered stiff competition to the manufacturer's line.

The manufacturer was required by the tripwire clause to give notice of the problem, to describe why he felt the distributor was in the wrong, and, more important, to offer "reasonable" (the word was in the contract) suggestions for breaking the impasse. A 60-day cooling-off period revealed that the manufacturer had underestimated the distributor's sales and local advertising expenditures. It also revealed that the new line of appliances would, in fact, compete with the manufacturer's products. Based on these determinations, the settlement was reasonable: The distributor dropped the competitive product line but retained its sales territory.

"Negotiate first" provisions. A society is based on the ability and readiness of people to work things out -- to accommodate each other's interests. A contract should promote that goal. For example, a contract might contain a clause that requires each side to engage in one month of good-faith negotiations before a lawsuit is filed. This means that both parties must genuinely try to negotiate quickly an acceptable settlement. For example, they ought to meet immediately, exchange views, and develop settlement options. In fact, refusals by one side to meet or to suggest terms of settlement could breach the contract and entitle the other party to damages. To increase the likelihood of a settlement in the negotiation, the clause could also require that the two executives who negotiated and signed the contract be the two negotiators in the event of a later dispute.

Contract provisions are sensible and enforceable ways to prevent legal disputes. But a company can adopt other techniques.

The dispute-management audit. Although most companies submit to annual financial audits, few systematically review the number, source, and nature of commercial disputes that arise. Periodic, perhaps yearly, reviews can spot, early on, potentially serious quality or marketing problems with particular products, sales regions, or product managers. A Texas electronics company, for example, discovered in its last annual review that there was a pattern of disputes and complaints involving the products marketed by one of its vice-presidents. The problem was not, as first thought, quality control of the products, but, rather, the abrasive management style of the executive. The vice-president was transferred to another position, and potential litigation was avoided.

RESOLUTION. Despite the best attempts at prevention, disputes inevitably arise. When they do, a company should try sensible and inexpensive ways to resolve them before proceeding to court. Jonathan B. Marks, a lawyer and president of EnDispute Inc., a Washington, D.C., consulting firm, says that lawyers are "extraordinarily uncreative in identifying ways to cut litigation costs."

Third-party advisers. A contract can require the use of a third-party mediator or facilitator, a procedure Marks recommends when the two-party negotiating process breaks down. This way, the businesspeople still make policy decisions, but the mediator keeps the process going and the parties talking.

Some mediators are employed by government agencies, such as the Federal Mediation and Conciliation Service and state labor-relations agencies. Others mediate part-time and can be found at universities, industry trade associations, and consulting and law firms.

In California, Judicial Arbitration and Mediation Services Inc., of Santa Ana, resolves a variety of civil disputes through mediation and other techniques. The service has been in business for three years and handles about 20 disputes a month, most of which involve claims of less than $25,000. According to H. Warren Knight, a former judge and the service's director, 90% of the matters are settled after a one- to four-hour conference of the parties at a cost of $60 per hour for each side.

Trial by management. If negotiation and mediation don't end the dispute, it is possible to change tactics and let the businesspeople become "judges." One way is to conduct a "minitrial" (see INC., October 1981, page 149). The first stage is for a representative of the company (often a company lawyer) to present its side of the case, not to a judge, but to senior executives of the two companies. This allows each side to see, for the first time, the full strength and weakness of both positions.

Then the two executives retire to hammer out a solution. In virtually all cases, a settlement is immediate, particularly if a neutral adviser is a member of the minitrial panel and is authorized to make his own recommendation. This voluntary procedure can be required in a contract or, more commonly, simply agreed to by the two companies when a dispute arises.

The purest version of the technique has been used so far only by the biggest companies and usually for complex problems in which millions of dollars are at stake. Less elaborate procedures have been devised when the stakes are smaller. For example, some beer and soft-drink manufacturers permit local wholesalers and distributors to take grievances to the senior executive of the manufacturer. This way both sides bypass the supplier's lawyers and sales representatives who may have spawned the dispute in the first place.

Businesspeople sometimes question how their direct participation in resolving legal disputes can save time, money, and headaches. It does because the person in business has a stronger motivation to solve the problem than the lawyers have; there are no expensive pretrial tactical maneuvers; company managers have more options available to them and more authority to exercise them than do lawyers; and head-to-head meetings among management are likely to produce more creative solutions than judges and juries might be able to offer.