General Overview Regarding Sources of Business Risk of Liability to Third Parties

This month of May, we will be addressing various issues related to operational issues for businesses.  This post will give an overview of the primary sources of risk an average business is subject to as it relates to third parties.

Taking a page from one of my favorite authors, C.S. Lewis, there are too equal and opposite errors for businesses.  The first extreme is the business which ignores potential liabilities to third parties as either extremely remote, or non-existent.  The other extreme is the business which is consumed by the fear of risks to third parties and sees such risks everywhere in everything.  Neither position is generally advisable.  Instead, a business should make itself aware of the potential risks of liability, determine the way such risks apply to their particular operations and industry, and then implement a strategy for minimizing the risks in a cost effective and efficient manner.

Liability

Duties

Generally, the legal system recognizes that persons have certain rights which should be protected.  Conversely, individuals are expected to refrain from violating other’s rights, and are required to remedy harms caused by violations of another’s rights.  In short, we all have legally recognized duties to each other.

Remedies

When a person fails to meet one or more of their duties, and that failure causes a recognized harm to another, the violator can be required to remedy the harm.  Most harms are remedied by monetary compensation.  However, in some situations, when a monetary remedy is inadequate, the remedy can be a physical requirement such as the requirement that a party engage, or refrain, from some harmful conduct.

With this in mind, here are the primary sources of business liability:

Sources of Liability

Common Law Duties

Common law duties are essentially expectations recognized by the courts.  They are not based on statutes.  They are obligations that may be social expectations or expectations based in public policy concerns.  Common law may vary from state to state.

Internally, two important examples of common law duties for businesses are the duty of loyalty and the duty of care.  The duty of care requires that persons with certain business roles such as directors and officers use the degree of care of a “prudent director or officer.”  At a minimum, this means the director or officer be informed of the relevant facts which would allow them to make an informed decision.  That duty will also generally require that directors regularly attend meetings. 

Officers and directors also have a duty of loyalty to the corporation they serve.  Similarly, partners and members or managers have the same, or a similar, duty.  They are considered fiduciaries of the business.  Accordingly, unless they have authorization, directors and officers cannot compete with the company or take opportunities from which the business would otherwise benefit. 

Externally, businesses also have a duty not to be negligent in its activities.  This generally means that a business must engage in a degree of care of a reasonably prudent person in its interactions with third parties.  Taxi companies have to drive non-negligently, and construction companies cannot create dangerous conditions for the public.

Contractual Duties

Duties also arise in contracts.  A contract is an exchange of promises between two parties.  If one fails to perform, it is a breach of the duty specified in the contract.  Usually a breach of contract will result in monetary damages.  However, some breaches will require specific performance where the court requires the breaching party to fulfill the promise.

Statutory Duties

Duties can also arise out of state or federal law.  Such laws usually expand or modify common law duties.  For example, the “at will” employment relationship has been significantly altered by statutes limiting terminations for various reasons.  See some of last month’s posts for examples of how current statutes affect both employees and independent contractors.  In addition, on the federal level, recent laws have been passed giving worker’s more rights to sued for over pay discrimination, preventing discrimination related to genetic information, and giving the federal government authority over executive pay for entities that receive TARP funds.  This is not an exhaustive list.  It should also be noted that each law has a corresponding regulatory scheme that is applicable.  Below are a few specific additional areas of statutory law that relate to business liability and risk.

Securities Law

The Securities Act of 1933 and the Securities Exchange Act of 1934 affects publicly-traded corporations and the professionals who represent them.  These laws relate create liability for parties involved in the issuance of shares to the investing public, as well as in the reporting made by such companies.  The Sarbanes-Oxley Act of 2002 also creates disclosure and corporate governance requirements for publicly-traded companies.  Other statutes, including state laws, also may be applicable.

Environmental Law

The federal Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (“CERCLA”) allows the federal government to shift the cost of cleanup of hazardous substance sites to responsible parties including owners, operators, hazardous substance generators, and transporters of the substances to the site.  The Resource Conservation and Recovery Act of 1976 (“RCRA”) creates rules for the generation, storage, transportation, use, and disposal of hazardous substances, creates fines and penalties for violators, and allows private citizen enforcement.  Other applicable statutes include the Clean Water Act, the Clean Air Act, and the Toxic Substances Control Act.

Intellectual Property and Unfair Competition Law

Different laws create property rights for some ideas and creations such as names, inventions, designs, original works of authorship, art, music, publications, trademarks, trade secrets and the like.  This type of property is referred to as intellectual property. The law grants owners of such intellectual property rights to protect the property against parties who misappropriate or misuses it, and while generally enforced by private parties, also the law may allow for criminal penalties.

In addition, certain laws are also aim to prevent unfair competition.  For example, the use of a trademark to deceive consumers is a form of unfair competition.  Another example of unfair competition laws are laws aimed at preventing restraints on trade or monopolies.  These are referred to as antitrust laws.  Antitrust laws may allow for private or government enforcement, and may include criminal penalties.

Occupational Safety Law

The Occupational Safety and Health Act of 1970 (“OSHA”) sets rules for workplace safety and establishes civil and sometimes criminal penalties for violations.  While generally aimed at employers, others may be liable in certain instances.  The law is only enforced by governmental agents.

Benefit Plans and Compensation

The Employee Retirement Income Security Act of 1974 (“ERISA”) applies to most employee benefit plans and imposes fiduciary obligations on certain persons who have some kind of discretionary management over the plan.  This can often include directors, officers, and employees of a business.  The duty is to act solely in the interest of the plan beneficiaries and to act with the same skill and care that an ordinarily prudent person would use in similar circumstances.  Violations of the duty can result in personal liability.

In addition, businesses are responsible for compensation of employees.  The Colorado Wage Claim Act imposes certain requirements regarding compensation.  Federal and state law also impose requirements regarding minimum wages and overtime pay.  Finally, deferred compensation may be subject to certain laws and tax requirements which can impose penalties.

Defense Obligations

Separate from the actual liability that might be imposed on a business for a violation of a duty, any claim of a violation of a duty includes an exposure to expenses in the form of defending against the claim.  These expenses include defense fees and costs.  Even if the claim is frivolous or groundless, the business needs to engage in defense or risk a default judgment.  A default judgment is a ruling by a court that the accused person is liable for all of the relief requested on the basis that the accused party has failed to timely respond to the charges in the complaint, and is therefore deemed to have admitted the allegations.  Accordingly, regardless of the merits of a claim, businesses have a risk of defense exposure to a possible third party claim.

Conclusion

The list of liabilities of a business above is not exhaustive.  Each business is unique and depending on the business, some risks will be greater or lesser than others.  However, addressing, managing and minimizing the risks through various activities such as insurance, policies and procedures, contract language, and the like, can only begin after the risks have been identified, considered, and evaluated.

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