Articles

DOES YOUR COMPANY NEED A LEGAL CHECKUP?

A step-by-step guide to examining your company's legal health.

Marshall H. Tanick
(email)
Mansfield, Tanick & Cohen, P.A.
1700 U. S. Bank Plaza South
Minneapolis, MN 55402
Tel: 800-401-6194
FAX: 612.339.3161

The notion of preventive law has taken hold among Minnesota businesses in recent years.

Prudent owners and managers of businesses recognize that the increase in litigiousness, a growing exposure to legal liability and mounting legal costs can best be curbed by anticipating legal problems before they occur. This requires analysis of general business circumstances and issues particular to your business, identification of potential legal pitfalls, and making advance arrangements to eliminate or minimize those deficiencies.

An effective and efficient device to achieve these objectives is a "legal checkup." The term, borrowed from the medical profession, denotes a systematic examination of current practices to reflect the condition of the enterprise. This includes recognizing which legal aspects of the business are healthy, as well as identifying and treating the unhealthy segments.

A legal checkup is not geared solely to mammoth businesses with sprawling operations. It is equally applicable to growing businesses. While the scope of the checkup varies with the size of the business, certain basic steps are covered in most instances.

A typical procedure for a legal checkup follows three stages.

1. First, the business owner acquaints the examiner with the general operation of the business and specific facets of it.

2. The examiner analyzes legal issues within each segment of the business.

3. The examiner writes a report and gives an oral briefing to management to communicate findings of the checkup. In addition, the business owner receives recommendations for solving problems that were discovered.

The following is a brief overview of what to anticipate in a legal checkup, from "A" to "Z."

• Attorneys. After you decide that your company should undergo a legal checkup, you need to determine who should perform the procedure. Irrespective of their talents and knowledge, lawyers with pre-existing relationships with the business are not best suited to perform a legal checkup. Often, they can't see the forest for the trees. Additionally, they lack the objectivity necessary to perform the task. Besides, a proper legal checkup should examine the role of attorneys in the business, including how effective and efficient the company is in utilizing legal counsel. The kinds of questions that must be asked and the advice that may be given should come from lawyers without any affiliation with the business or personal stake in the outcome.

• Contracts. All of the contracts involved in the operation of the business should be examined. These include employment agreements with executives; labor agreements (if organized-labor unions exist), arrangements with vendors, suppliers and customers; and other contractual relationships. In addition to examining current contracts, the legal checkup should examine whether the company should develop new contractual arrangements or provisions. Consideration should be given to using employment contracts, including noncompete clauses with key personnel who have access to important customers, trade secrets and other proprietary information. Arrangements for resolving disputes also ought to be evaluated as part of the contractual review. The company also should decide whether to include arbitration clauses in its contracts with employees, suppliers, customers and others.

• Employment issues. About 40 percent of all new lawsuits these days concern employment-related issues. An important aspect of a legal checkup is a thorough review of how the company handles employment matters, including practices before the employment relationship begins, during its existence and after its termination. Depending on the size of the business, number of employees and recruitments and hiring practices, the legal checkup may encompass the following:

  1. Examination of job-application and hiring forms for improper questions. Inquiries regarding race, gender, nationality, religion, marital status and other personal matters unrelated to job performance may be illegal and could cause legal liability. If application forms are used, sanitized versions should be prepared.

  2. Scrutiny of all personnel handbooks, employee manuals and other similar documents to ascertain whether the company has unwittingly entered in binding contractual commitments. Handbooks and manuals can be effective tools, but they should be cushioned with appropriate disclaimers or other language limiting legal liability.

  3. Review of practices followed in discipline of employees, particularly termination. Consistent and firm application of company policies should be followed in disciplinary matters. Procedures for disciplining or terminating employees should be standardized, and written records of disciplinary action, including events leading up to the discipline, should be maintained. The use of severance pay or other compensation at termination should be examined to see if it runs afoul of the broad policies under the Federal Employee Retirement and Income Security Act (ERISA).

• Environment. Environmental issues are becoming a major concern for businesses and are likely to spread to enterprises that haven't yet felt the brunt of environmental laws. In particular, employees and labor organizations are intensifying their pursuit of environmental claims. Therefore, it's essential that the legal checkup include analysis of activities that the company engages in that may have environmental overtones, ranging from use of hazardous products to disposal of rubbish.

• Grappling with the Government. Businesses that have significant relationships with governmental units constantly must be aware of existing and changing governmental regulations. Review of compliance with these regulations is an important part of a legal checkup. This analysis should determine whether the business complies with EEOC guidelines and related civil-rights requirements, prevailing wage laws, pricing standards and other requirements.

• Human rights. Companies must be sensitive to human-rights issues. Development of written policies regarding sexual harassment is advisable to prevent costly and fractious litigation. A legal checkup should determine whether such a policy exists, and if not, how one can be formulated and implemented.

• Insurance Issues. While insurance agents probably can determine the insurance needs of the business, a legal checkup definitely should analyze existing insurance policies. Scrutiny of existing policies is necessary to find out what kinds of risks and exposures to liability are covered and, more importantly, what coverage is omitted or excluded. Attention then can be directed to whether additional insurance is necessary or whether new policy language should be written to clarify existing provisions or furnish coverage for additional risks.

• Looming Litigation. All existing litigation, including administrative actions, lawsuits and other adversarial proceedings should be reviewed. A dispassionate analysis of pending proceedings may indicate which matters should be settled, which ones portend unfavorable results and ways of curbing legal costs. Lawyers involved in existing litigation often are incapable or unwilling to perform this kind of analysis. An across-the-board examination, therefore, is required by a disinterested observer.

• On the Offense. A legal checkup need not be solely a defensive procedure aimed at fending off legal problems. Rather, the checkup also should determine whether the company should take aggressive stances on certain issues to maximize its legal position. For instance, relevant practices of competitors that may be subject to legal challenge should be reviewed. It also may be appropriate to initiate legal actions on a number of fronts, such as protecting trademarks or other insignia, collecting marginal debts and pursuing insurance claims for property losses that have been languishing.

• Organic Documents. Familiarity with the structure of the business is essential for an effective legal checkup. This necessitates review of organic documents, including articles of the corporation or bylaws for incorporated business, partnership agreements, buy-sell arrangements and related documents that define the structure of the business relationship or the relationship between proprietary owners in the enterprise. Relations between any majority or controlling shareholders and minority owners should be scrutinized to determine whether possible legal claims lurk in them. Also, mechanisms for resolving internal disputes can be created in order to forestall fractious litigation in the event of disputes.

• Securities. Debt instruments issued by, or held by, a company should be analyzed in a legal checkup. Both federal and state laws and regulations broadly define the types of debt instruments that may be subject to securities laws. As a debtor, the company should find out whether its holdings fall within securities laws and, if so, what the consequences are for the company. Likewise, as a creditor, the company should ascertain whether its debt instruments come within the securities laws and if there are any implications if they do.

• Self Protection. A legal checkup should pay attention to how the company protects itself from harm or losses. It should review opportunities for embezzlement or other loss of property and ways to prevent such opportunities. In addition, it should analyze the possibility of loss of sensitive information or other proprietary data by employees and legal ways to prevent this from occurring. An alcohol and drug policy also might be contemplated, structured to comply with the Minnesota Drug and Alcohol Testing Law.

• Zealots. A legal checkup should aim for rooting out overzealous practices within the company. Employees who are personally committed to particular causes or who are trying to establish principles often end up costing companies significant amounts of money in litigation. Identification of these practices and procedures is essential as a step towards steering them into more productive business-like pursuits.

Management should be cautious when selecting its counsel to conduct the checkup. If the counsel works with competitors, a business would rightly feel uneasy baring its soul to the lawyer. Counsel retained for the checkup should be examined to determine if conflicts of interest exist, such as competition, and a confidentiality agreement should be part of the arrangement to assure that information gleaned during the audit is not wrongfully transmitted to competitors.

A checkup is not a panacea. There are a number of drawbacks that must be considered before deciding to undertake one. One significant consideration is ensuring confidentiality. Employees must be enthusiastic participants in the process, but they should not be recipients of information about the outcome of the audit until the checkup has been completed and management decides how to inform the staff of the findings and recommendations.

The cost of a legal checkup varies depending on circumstances. For a small business, the cost may be about $2,500. A larger enterprise may spend $7,500 to $15,000 or more on a legal checkup. Once a full-scale checkup is conducted, maintenance can be done on an occasional basis.

While the cost may seem high, companies that have undergone the process swear by it as a means of minimizing expenses in the long run. That's preferable to swearing at legal costs that arise when throbbing problems explode into major legal headaches.

In sum, a preventive checkup may prevent the need for a legal autopsy later.

This article originally appeared in Minnesota Ventures, July/August 1990 and has been updated to reflect current costs.

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