United Kingdom
Penny Wise, Pound Foolish
Why cost cutting increases businesses’ risk of litigation - Gervase MacGregor
We have come to expect an increase in commercial disputes during a recession, but why this is the case is less known. Do companies’ attitudes change, making them more combative and inclined to litigate? Or do they make decisions in response to a tough economic environment that unwittingly make them more vulnerable to disputes and problems that are likely to result in litigation?
We wanted to take a closer look at the likely causes of this increase in litigation during a recession so we commissioned a survey of CEOs and Financial Directors in the UK to find out a little more about their awareness of this risk and the measures they have put in place to handle it.
We asked them about the decisions that they were taking to manage their businesses through the recession and how this changed their perceptions of the nature and extent of the risk that they face.
Our survey showed that nearly 80% of UK CEOs and FDs believe that the recession has increased the number of risks that their businesses face and over 50% of them have sought to reduce costs or share financial risk since the beginning of 2008.
However, while it appears that a general sensitivity to risk has increased, there is a less precise grasp of the specific nature of the risks to which many businesses may be subject. This is demonstrated by the finding that 75% of the surveyed businesses do not understand that cost cutting exercises such as outsourcing have actually increased their risk of being drawn into litigation which can be both difficult and expensive.
Furthermore of particular interest and concern is that nearly two-thirds of the businesses surveyed (62 per cent) do not believe that the recession has exposed them to a greater risk of legal disputes or litigation.
But when asked about the specific risks that they believed their actions may have exposed them to, many cited issues such as damage to reputation and brand resulting from poor performance by subcontractors; reliance on outsourcers interrupting the quality or continuity of supply or commercial harm arising from damage to intellectual property or relationships with key customers. And these are all issues that are frequently the basis for disputes that can end in damaging and expensive litigation.
In addition three quarters of all businesses surveyed have sought to cut costs by reducing headcount, either through natural attrition - by not replacing roles - or through formal redundancy programmes.
Few businesses have managed to come through the challenging economic environment of the last 18 months entirely unscathed. The speed and extent of the recession has forced many to make tough choices and to find innovative ways to cut costs and manage their business.
It is evident from some of the disputes that we have been instructed upon that businesses often expose themselves to enormous commercial risks which can result in disputes and litigation. Measures, such as redundancies, outsourcing support services, relocating production facilities offshore or joint venture arrangements have the potential to deliver significant cost savings but measures that focus purely on the cheapest solution can sometime have unwelcome side effects on service delivery and profits. It can be extremely difficult for businesses to extricate themselves from such arrangements and the claims and counter claims require careful quantification.
In times of recession businesses run an increased risk of becoming embroiled in a wide range of disputes as contractual non performance and onerous contracts have a more significant impact on profits and the diverging interests of commercial partners and shareholders come into sharper focus. With recovery on the horizon we are beginning to see an increase in claims as contractual arrangements that are not delivering in line with expectations are coming under intense and critical scrutiny as businesses take stock of the merits of bringing a claim. In addition, the recession has flushed out many issues that would have been less significant or largely obscured in a time of generally good business performance.
Finally fraud that has remained undetected can easier come to light as a result of lower turnover or the redundancy of the fraudster.
The full results of the survey can be found in our Penny Wise, Pound Foolish report. In this report we also provide advice to businesses on what steps they need to undertake to prevent disputes and litigation as well as what to do if they are faced with litigation.
Gervase MacGregor is the National Head of Advisory and a partner within the Forensic Accounting stream. He can be reached at gervase.macgregor@bdo.co.uk