Every entrepreneur knows that to stay in business they must stay on the right side of the law. As ignorance is no excuse, MIKE PRESTON outlines SMEs’ 10 most common legal slip-ups.
By Mike Preston
The law has always been a minefield for business owners, but increased public scrutiny, and recent legislative changes, mean legal problems are now more likely to ruin an entrepreneur‘s reputation – or put them in jail – than ever before.
The public appears to be eager to see heftier penalties for legal breaches that take place in the business context, a sentiment that surfaced recently after the fall from grace of high profile Visy Corporation chairman Richard Pratt.
Pratt and Visy were fined $36 million for engaging in price fixing, an amount that many felt barely scratched the surface of his $5.4 billion fortune.
The new Rudd Labor Government quickly responded to public outrage over the penalty by announcing it would pass laws to impose jail sentences of up to five years for serious cartel conduct.
While not all entrepreneurs who make legal errors are publicly flayed like Pratt, even a relatively innocent failure to get the legals right can have serious consequences for a business – and its owner.
Lawyers say often entrepreneurs get into hot water because they fail to understand the business consequences of not addressing legal issues if there is a problem down the track.
When it comes to the law, business owners can’t afford to stick their head in the sand or just leave to the lawyers. It is much better to understand where the legal pitfalls lie.
Here is SmartCompany’s list of 10 of the most common errors business owners make, and how to avoid them.
The Visy/Pratt affair late last year saw price fixing take its place among the most heinous of business sins.
Price fixing essentially involves an agreement between competitors in an industry to go easy on each other – perhaps by secretly agreeing not to compete for certain tenders – in order to extract greater revenue from consumers.
While the most recent high profile cases have involved big business, SMEs should realise they are just as vulnerable to prosecution under anti-price fixing laws, according to Van Moulis, a competition law expert with Slater & Gordon.
Moulis cautions that seemingly innocuous actions, such as having a drink at the pub with a few of your competitors, can land a business owner in very hot water.
“There are several cases where blokes have been caught having a drink at the pub or a chat on the phone where it’s been wink wink, nudge nudge,” Moulis says.
“In one case all the scrap metal dealers in a part of Sydney would meet in a pub once a month and compare the tenders they were going to put in, and work out who would get what. They weren’t big businesses, but they got caught and paid the price.”
And that price can be serious. Financial penalties including fines of up to $500,000 per offence or, under legislation soon to be introduced into Parliament by the Government, a jail sentence of up to five years.
Moulis advises business owners to tread carefully in any dealings with competitors – and remember that the Australian Competition and Consumer Commission has been given coercive powers to seize any documents or computer records it needs to build its legal case.
When in export negotiations, knowing the difference between requiring goods to be delivered FOB, FAS or FBA can be the difference between a deal that makes money and one that loses it.
These acronyms – they mean Free On Board, Free Alongside Ship and Free Carrier respectively – and are just a few of the many accepted terms of international trade known as incoterms and, according to Lynda Slavinskis, principal of export consultancy and law firm Lynda Slavinskis Lawyers, exporters fail to understand them at their peril.
“Incoterms dictate fundamental issues, such as who carries costs and risks of transport, who is responsible for having goods delivered on time and who pays export and import fees – and they are the crux of any international trade relationship,” she says.
Slavinskis says she is constantly surprised at how many exporters, particularly those just starting out, don’t know of the incoterms, get them confused, or fail to have them included in contracts.
She tells the story of an Australian exporter planning to export fashion denim items to Britain and planning to compete with a price per pair of £200. What she didn’t understand, however, is that in Britain, the incoterm DDP – (delivered duty paid) the supplier is required to pay for import duties – applies by convention. When duties and freight costs were added into the price, each pair of jeans retailed for closer to £500.
“She just couldn’t compete at that price, and if she’d done her homework before negotiating the deal she may have realised it wasn’t going to be commercially viable to export into England, and perhaps looked to other markets,” Slavinskis says.
For exporters, the bottom line is that they need to understand the incoterms and, especially if they are exporting into a country for the first time, probably get expert advice on the terms of trade that are likely to apply in that particular market.
“They completely change the business decision and the whole legal relationship, so the legal issues and the business issues are totally inter-related – and, as usual with these things, it costs much less to understand what you are doing before negotiations than trying to fix things up afterwards, because you didn’t know what you were doing,” she says.
More information on incoterms can be found at the International Chamber of Commerce website and Wikipedia.
Many small business are started and run by friends, couples or family, with investors in the business drawn from the same narrow pool. Given the closeness of the relationships involved, and the thousand and one urgent priorities most business owners have on their plates, it is no wonder that having legal documents drawn up to govern them often gets put on the backburner.
In the early days of a business, there is not necessarily any problem with this, but when relationships break down, the lack of documentation to guide how the break-up should happen can make a bad situation disastrous.
Experienced commercial lawyer Deborah Chew, a partner in Melbourne firm Hall & Wilcox, says business owners often don’t see the point of drafting a partnership agreement while things are going well; but they fail to realise that it is usually too late to do anything about it once things start going pear-shaped.
“Time and again I see it, especially in small privately held companies. When things start falling apart there is nothing to guide the process and keep things out of the courts – it just happens with monotonous regularity,” Chew says.
The best way to save a business when its founding owners fall is generally to have one partner buy out the other. But once the bad blood starts flowing, Chew says, it can be very difficult to get to that point without resorting to litigation.
“Often a buy-out may be the only way forward, but one person is not willing to sell to the other or will insist on an exorbitant price, and often it is only ego getting in the way of a solution that benefits both parties,” she says.
Chew advises business partners to talk to each other and with key investors, come to a view about how things should be dealt with if the relationship has to end, and get a lawyer to draft a simple document setting out a process.
“Having clearly defined relationships between key parties can often help stop relationships from breaking down in the first place,” Chew says. “But even if things do go bad, at least they can keep things out of the courts or keep the costs of resolving the dispute to a minimum.”
For many business owners, the object of building a successful business is to make a lucrative exit somewhere down the track. What many don’t understand, however, is that selling what is otherwise a solid business can be made more difficult if its legal affairs aren’t in order.
It is all very well for a business’s operations, agreements and processes to be comprehensively understood by its owner, but, according to Deborah Chew, a prospective buyer will usually want to see things laid out in a more accessible and objective fashion.
“It can make the buyer really nervous if basic things such as shareholder agreements or supply contracts aren’t in good order – they begin to think that may reflect the business more generally,” Chew says. “It wouldn’t usually make the difference between buying and not buying, but it does make the process smoother and quicker if the buyer doesn’t have to worry if key contracts and documents are in order.”
Chew says a business owner considering selling should conduct an audit of legal loose ends that should include:
Even better, however, is to make sure records are accurately kept and legal documents drafted at the time when events take place or relationships are formed.
“It’s hard for someone running a business to pay attention to that sort of thing, but it can be important and very hard to fix things after the fact. People don’t remember the details of who did what or what happened when,” Chew says.
Ensuring intellectual property is secured is important for most businesses, but none more so than for those that are, or plan to, become a franchise.
Business owners can be so focused on building a successful and franchiseable business model that they forget that expansion of the franchise down the track will depend on holding registered brand trademarks in those markets.
Stephen Giles, a partner in Deacons Lawyers and expert on franchising law, says some franchise operators are taken by surprise by the rapid growth of their franchise into new markets.
“People just don’t register their brand in enough jurisdictions, and then when the time comes to expand internationally they find they can’t go with their brand,” Giles says. “They then have to come up with a new brand, which of course can be hugely expensive, plus they’ve got all the costs and complexities of trading in different markets under different brands.”
Although obtaining international trademarks can require an initial capital outlay, which can be a stretch for newer businesses, Giles cautions that by the time a business is growing and making substantial profits it can be too late to secure IP protection in key markets.
“There are people out there who are looking for brands that are doing it so that they can go and apply for trademarks in different countries. They are very organised in the way they approach things, and if they get in first they can make life very difficult for a franchise,” Giles says.
A key role lawyers often perform for their entrepreneur clients is to bring a necessary touch of pessimism to the creative process of building a business. The need for asset protection – in effect, protecting yourself from the fallout of possible business failure – is a classic example of precisely that.
“You need to start thinking about asset protection before you start business, but of course that is usually the last thing on entrepreneurs’ minds at that stage,” says Paul Brennan, speaker and author on business topics and principal of Brennan’s Solicitors.
But it is hard to deny the sense in ensuring that, should your business fail, you don’t lose the family house along with it.
The most basic form of asset protection is to arrange things so that, if one partner in a relationship is actively involved in the business, all the assets of the family are in the other’s name. The separation of the non-active partner from the business should also be emphasised by making sure they are not a director of the business.
The next step up as businesses get bigger is to incorporate, a measure that effectively puts personal assets out of the reach of creditors or litigants.
However, Brennan says, the usefulness of that strategy can be limited if banks or other creditors are given personal guarantees against personal assets of the business owner to secure credit.
Beyond that, a host of more sophisticated legal arrangements such as trusts are available that, with good legal advice, can provide stronger protection. Brennan advises that any business owner considering their asset protection options also consult an accountant on the financial implications of any move.
“Fancy stuff is fine and can be very effective, but you really need to be guided by your accountant because tax considerations can also be very important,” Brennan says.
Brennan says one of his most important jobs as a small town commercial lawyer is to advice his clients against taking legal action.
“At least once or twice a week someone will come in saying they want to sue the pants of people. Very occasionally that is fair enough, but most of the time I talk them out of it because, when all is said and done, the risk and costs of litigation completely outweigh whatever damage they have suffered,” Brennan says.
The most ill-advised cases are often those involving defamation, Brennan says. “It is a ‘he said, she said’ thing that often gets down to ego and who is going to spend the most money before the other side gives up. Usually it’s not until both sides have spent $5000 and not got anywhere that they realise it’s better just to go home.”
The bottom line, Brennan says, is that litigation is an activity for people with a thick hide and very deep pockets. “For an SME, taking litigation to its conclusion will often be a make-or-break the business, depending on the outcome, so it should be seen as a last resort.”
It may sound a little self-interested coming from a lawyer but, Brennan says, it is in the best interests of business owners not to change lawyers unless absolutely necessary.
The nature of the service lawyers provide their clients means that they will often need to advise them of the costs or risks associated with given activities, and even in some cases just advise flat out that something can’t be done.
This means that can-do entrepreneurs sometimes perceive lawyers as obstacles to success and gives rise to the temptation simply to shop around until a lawyer can be found who will give the right answer.
What this ignores is that the advice lawyers give – “don’t litigate”, “those regulatory hurdles can’t be overcome” – is often given contrary to their own commercial interests, but in the hope of maintaining a fruitful relationship over the longer term.
Remove the relationship, and the incentive to say no in the interests of your business is diminished, Brennan says.
“It is important to keep a relationship with your lawyer – they will be more likely to understand if you don’t pay bills regularly or take that urgent phone call. Just remember they’re not there to give out tea and sympathy; they are there to tell you how it is, in disinterested way,” Brennan says.
Australia’s industrial relations system is complex and constantly changing, so it is no surprise that SME owners are often left guessing about whether their employees’ pay and conditions satisfy legal requirements.
Kliger Partners industrial law practitioner Rob Jackson says, especially as businesses grow and take on employees to perform different tasks, industrial arrangements that were initially quite adequate can become inappropriate.
“We see SME owners who are quite innocently unaware that everything is not as it should be, just because they struggle a bit to get the information they need. They almost always want to do the right thing, and often the employees themselves don’t realise something is amiss,” Jackson says.
The high political profile given to industrial relations, and the scrutiny given to pay and conditions under instruments such as AWAs, means employers are now much more likely to find themselves under investigation for underpayment or breach of an award condition.
“Good employers are coming under investigation by the Workplace Ombudsman for underpayments. Usually they are shocked to find out, and rectify the situation immediately, but if a lot of employees are involved the payment required can be significant,” Jackson says.
He advises employers to seek out information on the entitlements of their workers, especially when hiring people to perform new tasks within the workplace – they may come under a different award to other employees – or if the workforce is expanding rapidly.
Employment information can be obtained from lawyers, employer associations or government authorities such as the Workplace Authority. Websites such as Wagenet can also be a good place to start.
The departure of a key employee is always a disturbing event for a business, but the situation becomes that much worse if they are able to take key client lists or company secrets to the competition.
Businesses will often go to great lengths to ensure that IP protections are in place for their products or manufacturing processes, but then forget to do anything to prevent employees walking out with client contacts or sales lists.
Businesses can protect themselves by ensuring employee contracts contain restraint clauses, Kliger Partners senior associate Rob Jackson says.
Restraint clauses limit the kinds of work your employees can do when they depart so that they can’t quickly move to performing the same work for your direct competitor.
They also restrict the information former employees can take with them from their former workplace, and prevent them attempting to solicit customers to follow them to their new employer.
Jackson says these clauses can be effective, but it is important for employers to realise that they can only impose reasonable limits on former employees – restraint clauses can’t be used to prevent them using their skills to make a living.
“If you try and stop someone working for 12 months in any similar business in the whole of Australia a court isn’t going to enforce that, so if you use a restraint clause it needs to be tailored to the nature of the job and not be over ambitious,” Jackson says.
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