In-House Counsel, Litigators, Money

Inside Straight: Charging Litigation Losses to Business Units

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Ed. note: This is the latest installment of Inside Straight, Above the Law’s new column for in-house counsel, written by Mark Herrmann.

Here’s an issue that outside counsel never think about, but that matters intensely to in-house counsel: How should you charge business units for litigation losses?

For some types of cases, this poses no problem at all. If a company manufactures a prescription drug and gets named in product liability cases involving that drug, it’s pretty easy to figure out which business unit to charge for resulting judgments. (At least I assume that’s true. Perhaps some reader who works in-house at a drug company can correct me if I’m mistaken.)

But think about negligence cases in the context of a service business. At first blush, charging for litigation losses seems pretty easy: The business unit that was negligent and caused the loss should be charged for any resulting judgment.

If only it were so clear. Think about the complexities here: Some clown at the business unit screws up in 2005. The company is named in a lawsuit that’s filed in 2007. The clown changes jobs and leaves the company in 2008. The lawsuit results in a $10 million judgment in 2010. How do you account for that $10 million charge internally?

At the outset, there’s no ability on these facts to punish the sloppy employee. The employee left the company years before the judgment was entered. The question is only how to allocate the loss among those employed by the company at the time of the judgment.

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On the one hand, you could immediately hit the business unit responsible for the negligence with an unbudgeted $10 million loss. That charge would cause the business unit to miss its budget, and would reduce (or eliminate) annual bonuses for everyone in the unit. If the judgment were entered early in the year (in, say, January), then any sentient person in the business unit would know that the bonus pool had just been destroyed for the year, and some high-performing employees might choose to find jobs elsewhere, where the chance for earning a bonus remained intact. Forcing the business unit to take the hit immediately could thus be a poor choice.

On the other hand, surely the business unit should be made to pay for its errors. If litigation costs are not charged back to business units, there’s no incentive for quality control. A unit would prosper by pushing a high volume of low-quality services out the door and letting some other part of the company (perhaps a general “litigation” budget) take the hit when the malpractice later came home to roost. If business units aren’t forced to internalize the costs of their errors, the units won’t maximize their true profitability.

Another possibility is to spread the hit to the business unit over time. The business unit could be charged $2 million per year for each of the next five years, which would internalize the cost of the error without destroying the unit’s performance in a single year.

Or the cost of the judgment could be charged to the business unit over time and also capped at some level. Thus, the rule could be that the cost of judgments is charged over a five-year period, and the charge in any one year could never exceed $1 million, with the $5 million that would go uncharged to the business unit handled in some other way (that is, paid by some other budget).

There’s no perfect answer to this, and different corporations surely handle the issue differently. But this is an issue that merits serious thought by in-house legal departments (and business units), and outside counsel should at least be aware of, and sensitive to, the topic.

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Earlier: Prior installments of Inside Straight

Mark Herrmann is the Vice President and Chief Counsel – Litigation at Aon, the world’s leading provider of risk management services, insurance and reinsurance brokerage, and human capital and management consulting. He is the author of The Curmudgeon’s Guide to Practicing Law.

You can reach him by email at inhouse@abovethelaw.com.

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