SMALL BUSINESS OWNERS and THE CANADIAN LEGAL SYSTEM

SMALL BUSINESS OWNERS and THE CANADIAN LEGAL SYSTEM Understanding small business experience and attitudes toward legal disputes Helping small business owners understand and protect themselves from unexpected legal costs

FOREWORD A message from The Canadian Bar Association The Canadian Bar Association (CBA) has been advocating on the issue of access to justice for Canadian families for many years. That advocacy also extends to millions of self-employed and small business owners, who face similar challenges in accessing our legal system. This research provides key insights about the frequency and types of legal issues small business owners face. While many are fully aware of the significant financial and business impact a legal dispute would have on their business, it is surprising how few budget for it, how many are unrepresented in court and feel unprotected by their traditional commercial insurance portfolio. That is why we are pleased to work in partnership with organizations like DAS Canada, to promote legal expense insurance as one of many solutions to increase access to justice for Canadian families and small business owners. This white paper highlights the many advantages legal expense insurance has to offer. It makes a compelling case and is a worthwhile read for anyone concerned about the impact legal issues could have on a key pillar of the Canadian economy. Sincerely, John Hoyles Chief Executive Officer Canadian Bar Association 2

INTRODUCTION With average hourly rates for lawyers running at just under $400 per hour, unforeseen legal expenses can represent a significant risk for any business. Smaller businesses, with fewer or no in-house resources, are often unable to absorb the financial and operational impacts of unexpected legal events. So then, how do Canadian small business owners feel about unforeseen legal expenses? How much experience have they had with the Canadian legal system? Are legal disputes, whether handled in or out of court, an inevitable aspect of doing business? What types of legal disputes have small business owners been involved in, and how have they attempted to resolve them? Do owners properly appreciate the potential risks of legal disputes, and how are they attempting to protect themselves from these risks? In an effort to answer these questions DAS Canada hired Ipsos, one of the world s leading survey-based marketing research firms, to gauge the opinions of Canadian small business owners and document their interactions with the Canadian legal system. Here s a look at the key findings of our Small Business Research Survey and some of the insights into small business owners experience, attitudes, and intentions. 3

THE CANADIAN SMALL BUSINESS LANDSCAPE Canadian small business owners fall into either one of these two sub-groups: 1 Self-employed business owners, with no paid employees. 2 Small-medium business (SMB) owners, with 1 to 99 paid employees. 1 2 2.7 million Self-Employed Owners with no paid employees 1.2 million Businesses with 1 to 99 employees 1 PRIOR LEGAL EXPERIENCES Significant numbers of small business owners have had experience with the Canadian legal system. In the last three years 3 in 10 had to deal with a legal dispute, defined as a situation whereby the small business owner and the other party both hired their own lawyers to resolve the issue. 12% of small business owners then took the next step of going to court to resolve a dispute over that same period of time. We also observed important differences in past legal experience between SMB and self-employed owners. 42% of SMB owners (approximately 504,000 businesses) had dealt with a legal dispute, compared to only 16% of selfemployed owners (about 432,000 individuals). When it comes to taking the final step of going to court to resolve a dispute, 20% of SMB owners (about 240,000 businesses) had done so over the past three years, compared to only 4% of self-employed owners (approximately 108,000 individuals). Although the percentages may seem low, the absolute number of businesses and individuals involved is substantial. Plus that absolute number of legal disputes and court appearances is likely to grow over time. This is based on continuous year-over-year growth in the number of active small-medium businesses, which increased by over 19,000 between 2011 and 2012, and an increase in the total number of self-employed Canadians, which grew by over 17,000 between 2014 and 2015. 2 Are legal disputes a less frequent risk event than other insured commercial risks? 4 out of 10 U.S. small businesses are likely to experience a property or general liability claim in the next 10 years. 3 Unfortunately, comparable Canadian insurance data could not be found at this time. However, considering 3 out of 10 Canadian small businesses faced a legal dispute during the past 3 years, it is clear legal risk events are just as relevant as a fire, commercial auto or bodily injury risk event. 4

THE REASONS FOR LEGAL DISPUTES AND GOING TO COURT OVER THE LAST 3 YEARS: 29% OF SMALL BUSINESS OWNERS PARTICIPATED IN A LEGAL DISPUTE 12% OF SMALL BUSINESS OWNERS WENT TO COURT OUR RESEARCH FINDINGS ESTIMATED IMPACT SMALL BUSINESS OWNERS WHO FACED A LEGAL DISPUTE FOR: % DEALT WITH LEGAL DISPUTES % GONE TO COURT # DEALT WITH LEGAL DISPUTES # GONE TO COURT Collecting money from customers 19% 7% Self-employed 11% 2% 297,000 54,000 SMB owner 26% 12% 312,000 144,000 Contract disputes with customers 13% 4% Self-employed 5% 1% 135,000 27,000 SMB owner 20% 8% 240,000 96,000 Contract disputes with suppliers 9% 5% Self-employed 2% 0% 54,000 - SMB owner 17% 9% 204,000 108,000 Employment disputes 7% 4% Self-employed 1% 1% 27,000 27,000 SMB owner 14% 8% 168,000 96,000 Appealing tax audit decisions 7% 4% Self-employed 2% 1% 54,000 27,000 SMB owner 12% 8% 144,000 96,000 Trespass, damage, or interference to property 7% 4% Self-employed 1% 0% 27,000 - SMB owner 12% 8% 144,000 96,000 Appealing regulatory or licensing decisions 6% 3% Self-employed 1% 0% 27,000 - SMB owner 11% 7% 132,000 84,000 Third party injury to employees 5% 3% Self-employed 0% 0% - - SMB owner 10% 6% 120,000 72,000 All legal disputes 29% 12% Self-employed 16% 4% 432,000 108,000 SMB owner 42% 20% 504,000 240,000 Research Assumption: We were initially surprised some self-employed business owners responded that they had an employment related legal dispute. However, upon further discussion we ve made the assumption these disputes may relate to: Part-time and/or seasonal employment, or; The self-employed business owner had full-time employees at some point during the past 3 years, but has since downsized their business to just themselves at the time of the survey 5

REASONS FOR PARTICIPATING IN LEGAL DISPUTES AND GOING TO COURT Being involved in a legal dispute or going to court can be costly, disruptive and stressful. We discovered that the decision to engage in a dispute or go to court depended greatly on the type of legal issue involved. Small business owners explained the most common reasons for participating in legal disputes or going to court over the last three years were: Collecting money from customers (19% had been involved in a legal dispute and 7% had gone to court); Contract disputes with customers (13% and 4%); Contract disputes with suppliers (9% and 5%); Employment disputes (7% and 4%); Appealing tax audits (7% and 4%); and Trespass, damage, and interference to property (7% and 4%). Many of the stated reasons for involvement in a legal dispute or going to court also highlight gaps in coverage found in traditional commercial insurance policies. While employment practices liability policies may cover certain employment disputes, and errors and omissions policies for advice or service professionals may cover legal defence costs in a contract dispute, the other reasons identified above all reflect clear coverage gaps in common commercial policies. Furthermore, many commercial policies require an act of negligence to occur for legal defence cost coverage to begin; with a legal expense insurance policy, a legal dispute initiates coverage for defence or plaintiff legal costs. We also found out that SMB owners were more than two-and-a half times more likely than self-employed owners to have faced a legal dispute over the last three years (42% vs 16%) and five times as likely to have gone to court (20% vs 4%). The logical conclusion is that increased business activity, revenue, and number of employees all serve to increase the risk of legal disputes. We also wanted to get a sense of what other factors increase the probability of participation in a legal dispute and going to court to seek resolution. We found the groups most likely to have participated in legal disputes and gone to court were: % OF DIFFERENT DEMOGRAPHIC GROUPS WHO HAVE: Personally know an owner who has lost a business due to legal expenses Annual revenue between $500,000 to $999,999 Annual revenue over $1,000,000 Franchisee Manufacturing sector Established and growing rapidly DEALT WITH DISPUTES 63% 63% 61% 56% 50% 47% GONE TO COURT 45% 41% 28% 47% 29% 26% 6

APPROACHES TAKEN TO RESOLVE DISPUTES 29% Of all small business owners have always gone to court without legal representation 67% Of self-employed owners have always gone to court without legal representation It is apparent many small business owners have had some level of experience engaging the Canadian legal system. Despite this, we discovered that nearly 3 in 10 small business owners, including two-thirds of selfemployed owners, have always tried to navigate the legal system without proper legal representation. The impact of not having legal representation on the success of a court action can be significant. According to a series of published legal studies, individuals who receive legal assistance are 17% to 1,380% more likely to achieve a better result than those who do not. 4 Therefore it is safe to assume, the benefits of hiring a lawyer could be expected in commercial litigation as well. Small business owners were more likely to try to resolve certain types of disputes on their own as a first step. The most common types of disputes they tried to resolve without legal representation were: Trespass, damage, and interference to property (44%); Collecting money from customers (43%); Employment disputes (41%); Contract disputes with customers (33%); Appealing regulatory or licensing disputes (31%); and Third party injuries to employees (31%). We know many small business owners are very involved in their business, and that navigating the legal system takes time and creates considerable stress. Given this, one can reasonably deduce that a reason behind the decision not to hire counsel reflects cost concerns, which is supported by our findings on the next few pages. 7

SMALL BUSINESS OWNERS AND THEIR DECISIONS TO HIRE COUNSEL NATURE OF DISPUTE % ALWAYS CHOOSING NOT TO HIRE TA X Appealing tax audit decisions... 27% Contract disputes with suppliers... 27% Appealing regulatory or licensing decisions... 31% A third party injures employees... 31% Contract disputes with customers... 33% Employment disputes... 41% Collecting money from customers... 43% Trespass, damage or interference to property... 44% All Small Business Owners... 29% LEGAL DISPUTES AND THEIR PERCEIVED IMPACTS The number of small business owners who chose not to hire a lawyer is quite at odds with owner perceptions of the potential impacts a legal dispute would have on their business. 73% of small business owners believe a legal dispute would have a tangible impact on their business s finances. Over half felt it would affect their productivity and their reputation, while almost half perceived it would impact their business s strategic focus. 8

IDENTIFYING THE IMPACTS OF LEGAL DISPUTES 26% 27% 9% Of small business owners have a law firm on retainer Of small business owners that had a legal dispute in the last 3 years plan to increase their legal budget Of small business owners plan 11% to increase their legal budget Of small business owners have set aside budget to cover unexpected legal expenses % ANSWERED YES Set aside for unexpected Legal expenses? SELF-EMPLOYED 17% SMB OWNER 37% Hired a law firm on retainer? SELF-EMPLOYED 3% SMB OWNER 15% 27% 9% % YES to ALLOCATED AMOUNT 20% 19% % under $1,000 % between $5,000 - $9,999 SELF-EMPLOYED 31% SELF-EMPLOYED 14% SMB OWNER 16% SMB OWNER 21% 33% 28% % between $1,000 - $4,999 % over $10,000 SELF-EMPLOYED 42% SELF-EMPLOYED 12% SMB OWNER 29% SMB OWNER 34% % BELIEVING A LEGAL DISPUTE WOULD AFFECT THEIR: FINANCES 73% REPUTATION 55% SELF-EMPLOYED 75% SELF-EMPLOYED 56% SMB OWNER 70% SMB OWNER 54% PRODUCTIVITY 56% STRATEGIC FOCUS 47% SELF-EMPLOYED 58% SELF-EMPLOYED 46% SMB OWNER 55% SMB OWNER 48% Self-employed and SMB owners had very similar perceptions of the tangible impacts a legal dispute could have on their business. Groups perceiving the greatest potential business impacts from legal disputes were: Start-up owners; Franchisees; Those in financial and insurance services; Those who knew someone who had lost their business due to legal expenses. Despite the broadly-based recognition of how significantly a legal dispute could harm their business, it appears that the great majority of small business owners are ill-prepared to deal with these impacts. Even though a two-day civil action can cost up to $44,000 in lawyer s fees, 5 only one in ten small business owners have a law firm on retainer, and only three in ten have set aside budget for unexpected legal expenses. Therefore legal expense insurance provides a solution to fill the financial gap for small business owners that had not aside budget or allocated too little to cover unforeseen legal expenses. Plus for SMB owners that take the proactive step to set aside a legal rainy day fund, legal expense insurance can be an attractive means to free-up some of those dollars for use elsewhere in their business. 9

HOW SMALL BUSINESS OWNERS PLAN TO PAY FOR UNEXPECTED LEGAL EXPENSES We have already learned that 7 out of every 10 small business owners do not have a budget set aside for handling unforeseen legal expenses, which can cost up to $119,000 for a 7 day civil action. 6 How then do small business owners plan to pay for any unexpected legal expenses? 69% indicated they would absorb legal expenses as a cost of doing business and allow these costs to impact their bottom line. 15% said they would cut back on other operational expenses to avoid affecting their profitability, 8% said they would divest business assets, and 6% indicated they would put a law firm on retainer. 69% HOW BUSINESSES WOULD PAY FOR UNEXPECTED LEGAL EXPENSES Absorb the legal expenses as a cost of doing business & take a profit hit Cut back operational expenses Divest business Assets Pay an annual retainer to a law firm & take a profit hit Other 68% 71% 15% 8% 6% 10% 19% 11% 9% 7% 12% 5% 4% 14% SMB OWNER SELF-EMPLOYED Unfortunately, the strategy to absorb legal expenses as a cost of doing business may result in small business owners having to pay the ultimate price for dealing with unforeseen legal disputes; closing their business s doors for good. It is surprising that a little more than 1 out 10 Canadian small business owners know someone who lost their business due to lawyer s fees and related costs to settle a legal dispute. 10

SMALL BUSINESS OWNERS AND THEIR ASSESSMENT OF RISK PERCENTAGE OF SMALL BUSINESS OWNERS THAT KNOW SOMEONE WHO LOST THEIR BUSINESS DUE TO A LEGAL DISPUTE Small Business Owners SMB Owners Self-employed Business Owners 5% 12% 19% 0% 5% 10% 15% 20% Given everything we ve learned, how significant a concern are unexpected legal expenses to Canadian small business owners? The greatest concerns voiced by small business owners are general economic uncertainty (36%) and data security/cyber-crime issues (24%). This is not surprising, given the high degree of current media coverage these topics attract. However, given the widespread recognition of how significantly unexpected legal costs could impact their businesses, only 16% of small business owners cited them as a concern. Considering the frequency of legal disputes faced by small business owners and that 73% said such disputes would have a tangible financial impact, an important question needs to be asked. Are small business failing to connect the dots, in realizing how significant a business risk a legal dispute could have on them? CURRENT WORRIES OF CANADIAN SMALL BUSINESS OWNERS Broad economic uncertainty Data security, technology and cyber risks Complying with tax code changes Increasing commercial insurance costs Complying with regulatory or business licensing changes 36% 24% 22% 21% 21% SELF-EMPLOYED 28% SMB OWNER 43% SELF-EMPLOYED 18% SMB OWNER 30% SELF-EMPLOYED 15% SMB OWNER 29% SELF-EMPLOYED 12% SMB OWNER 31% SELF-EMPLOYED 15% SMB OWNER 28% Increasing legal liability and legal costs 16% SELF-EMPLOYED 8% SMB OWNER 25% Increasing employee benefit costs 16% SELF-EMPLOYED 4% SMB OWNER 28% 11

SMALL BUSINESS OWNERS AND LITIGATION To go deeper, we then asked how concerned Canadian small business owners are about the risks of litigation. 3 in 10 Canadian small business owners indicated they were very or somewhat worried about being sued by at least one of these groups. Customers were the group causing the most concern, followed by government agencies, and then shareholders or other investors. Surprisingly, only 12% of small business owners overall felt they had sufficient insurance coverage if sued or taken to court by any of the groups. PERCENTAGE OF SMALL BUSINESS OWNERS THAT ARE WORRIED ABOUT BEING SUED BY ONE OF THESE SPECIFIC GROUPS Customers Government Regulatory or Tax Agency Shareholders or Other Investors General Public Employees Suppliers 0% 15% 19% 18% 23% 22% 21% 5% 10% 15% 20% 25% 31% Of small business owners are worried about being sued by at least one plaintiff group ONLY12% Of small business owners felt they had sufficient insurance coverage if sued or taken to court by any of these plaintiff groups Given the small percentage of Canadian small business owners who felt they had adequate insurance coverage for unexpected legal expenses, we wondered about the appeal of legal expense insurance. Would small business owners find an insurance policy covering all legal expenses related to employment or contract disputes, collecting debts, appealing a business licence decision, defending against a tax audit, and offering general legal advice on any legal matter, appealing? If offered such a policy, almost 6 in 10 small business owners indicated they would purchase coverage. Of this group, 57% indicated they would buy a policy if it were priced at $1,260 per year, which is the average annual premium for a DAS commercial legal expense insurance policy, suggesting this price point is an appealing and affordable one for Canadian small business owners. 58% Of small business owners indicated an intent to purchase legal expense insurance based on a single sentence description APPEAL AND PRICING OF LEGAL EXPENSE INSURANCE Purchase a policy that covers all legal expenses? All Small Business Owners 58% Self-Employed 47% SMB Owner 68% If plan costs $1,260 per year? All Small Business Owners 57% Self-Employed 42% SMB Owner 68% 12

IN CONCLUSION 3 out of 10 small business owners are likely to face an unforeseen legal dispute in the next three years. The vast majority of those same business owners also believe a legal dispute would have a tangible impact on their business s finances. However, 73% have not set aside any kind of budget for unplanned legal expenses, which can run up to $44,000 for a two-day civil action. This forces too many Canadian small business owners to make an uncomfortable decision: to walk away from a legal dispute, take action on their own without a lawyer or to have those costly legal fees hit their bottom line. That s just the financial risk small business owners are taking, when they do not connect the dots between legal fees and their own past legal experiences with employees, customers, suppliers or the government. It is also interesting that 31% are worried they will be sued and taken to court by one of the above potential plaintiff groups, yet only 12% believe they have adequate commercial insurance coverage to protect them. So in addition to a financial gap, many small businesses face a coverage gap as well. It s not only a perception gap, but many legal risk events such as plaintiff contract disputes coverage, collection of money owed, appealing a business license decision or a Canada Revenue Agency tax audit are not typically covered by traditional commercial insurance policies. To fill those gaps, small business owners should consider adding legal expense insurance to their commercial portfolio. Ignoring price and based on a single sentence description 7 of the core benefits of a legal expense insurance policy, 58% of Canadian small business owners said they would buy it. Of this group, 6 out of 10 stated they would still buy a legal expense insurance policy at an annual premium of $1,260. By asking questions and by having this research start a discussion, we believe the dots will become connected and more prominent, as to the significant financial and business risks an unforeseen legal event can have on a small business owner. 1 out of 10 Canadian small business owners know someone who lost their business due to a legal dispute. That is simply too high! Therefore insurance carriers, brokers, government and small business community leaders need to work together, to raise awareness of commercial legal risks and that legal expense insurance is an access to justice solution for Canadian small business owners. 13

ABOUT THE DAS SMALL BUSINESS RESEARCH SURVEY The DAS Canada Small Business Research Survey is based on the findings of an Ipsos poll conducted from January 12 to 20, 2015 on behalf of DAS Canada. For this survey, Ipsos conducted online interviews with a sample of 1,005 small business owners from Ipsos Canadian online I-Say panel. The sample was compiled to achieve as close to a 50/50 split as possible between self-employed owners with no paid employees (n=502) and small-medium business (SMB) owners with 1-99 paid employees (n=503). With a survey sample of this size, the results are considered accurate to within +/-3.5 percentage points had the entire population of Canadian small businesses been surveyed. All sample surveys and polls may be subject to other sources of error, including, but not limited to, methodology change, coverage error, and measurement error. Endnotes: 1. Statistics Canada CANSIM table 551-0006 as of June 2014 & CANSIM table 282-0012 as of year-end 2013. 2. Statistics Canada CANSIM table 529-001 as of December 2012 & CANSIM table 282-0089 as of January 2014 vs January 2015. 3. Insurance Journal 10 Most Common and Costliest Small Business Claims, April 9, 2015 4. Canadian Bar Association Towards National Standards for Publicly Funded Legal Services, April 2013 5. Canadian Lawyer Magazine Canadian Lawyer s 2014 Legal Fees Survey, June 2014 6. Canadian Lawyer Magazine Canadian Lawyer s 2014 Legal Fees Survey, June 2014 7. Ignoring price, if you could have an insurance policy that covered all legal expenses related to settling an employment or contract dispute, collecting debts owed to your business, appealing a business licence decision, defending against a tax audit and offering general legal advice on any legal matter, would you buy it? 14

DAS Canada is part of DAS Group, the global market leader in legal expense insurance and a subsidiary of ERGO - the primary insurer of the Munich Re Group. We are the market leader in legal expense insurance in Canada, and the only insurance company to specialize in this class of insurance across the country. We empower individuals and businesses when they re faced with unexpected legal issues. A DAS policy: Protects clients from costly legal expenses; Defends or pursues a client s legal rights; and Gives clients access to legal advice at any time. Unlimited access to legal advice, a carefully selected panel of law firms to provide expert representation when making a claim, and the cost certainty of an annual premium make legal expense insurance an effective means for small business owners to protect themselves against the risks and costs of unexpected legal events. To learn more, please visit www.das.ca