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Liability Litigation and Entrepreneurship: A Delicate Balance

on August 24, 2009 Source: Policy Dialogue on Entrepreneurship

Last week, I highlighted the need for a smart regulation frameworkthat doesn’t inhibit entrepreneurship. Today, I would like talk aboutliability litigation in more specificity. All businesses should beconcerned about the inherent risk of bringing a new product or serviceto the market. However, entrepreneurship can suffer if liabilitylitigation is pursued in ways that create too much uncertainty.

Litigationuncertainties increase the level of risk that entrepreneurs have totake in order to work on their innovative ideas. According to a SBA study,liability litigation affects entrepreneurs’ chances of growing theirbusinesses by imposing costly and time-consuming settlements, legalfees and insurance. All this is reported to cause financial andpsychological hardship. Moreover, the majority of U.S. small firms areunincorporated, which means that many entrepreneurs are potentially subjected to personal as well as business financial liability risk.

The problem is real. It is estimated that over 20% of small-business owners spend more time on actual and potential liability problems than on productive business activities,such as introducing new technologies or processes, obtaining orrepaying business loans, and evaluating the competition. Smallbusinesses are also often the target of frivolous suits because theyare more likely than large corporations to settle a case rather than to litigate.By a 9 to 1 margin, suits against small businesses are settled beforetrial. Not surprisingly, small-business owners ranked the cost andavailability of liability insurance second on a list of 75 concerns.

Althoughprogress has been made in reducing the uncertainties surroundingliability costs, further reforms are needed to strike a balance betweenincentives for safety and innovation (and all the positive by-productsfrom innovations- jobs, higher quality of life, and more). For example,it is worrying that U.S. liability rules emerge from individual,fact-specific litigated cases randomly filed across the country, creating an uncertain legal climate for entrepreneurial endeavors.

Policymakers shouldconsider a federal product liability law to establish more uniformityto reduce uncertainty in liability rules for products sold ininterstate commerce. Or, to deter rent-seeking “sham” litigation, wecould adopt the English rule on payment of attorneys’ fees (loser pays)for commercial litigation where there are commercial interests on bothsides.

Let’s keep entrepreneurs doing what they do best to createjobs – and try to keep them somewhat protected from too muchcatastrophic and unpredictable liability.

JonathanOrtmans is a senior fellow at the Kauffman Foundation where he focuseson public policies to promote entrepreneurship in the U.S. and aroundthe world. In addition, he serves as president of the Public ForumInstitute, a non-partisan organization dedicated to fostering dialogueon important policy issues.

Category:  Liability Litigation 

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