Introduction
Legal is one of the external factors affecting a business according to the PESTEL (political, economic, social, technological, environmental, legal) model. Legal risk not well managed can manifest through lawsuits or litigation, penalties, cancellation or non-renewal of licences or permits or other adverse situations.
Managing legal risks
This article is simplified to accommodate the wide readership. Businesses are encouraged to come up with risk management frameworks or systems to mitigate legal risks. It is quite common to find a legal and compliance as well as risk function or resource person in a business depending on size. Some of the aspects considered in managing risks include those explained hereunder.
Risk identification
This involves identifying legal risks likely to affect a business. This process involves coming up with a broad list of identified potential legal risks. The main sources of legal risks are regulations and contracts. Legal disputes can escalate to litigation which can be both disruptive and expensive.
Put differently, many legal risks emanate from regulatory laws or requirements especially for regulated businesses. There are many regulated businesses which require licences or permits some which are renewed annually. These usually have conditions which have to be complied with. Other significant stakeholders to a business include ZIMRA, Environmental Management Agency (EMA) and local authorities.
Contracts are a major source of legal risks due to many reasons. Common examples include non- compliance by the business or another party to an agreement or when a party is simply attempting to avoid contractual obligations or attempting to benefit unfairly.
In some situations a supplier may attempt to pass on a price increase to a customer or a customer may fail to pay on time or choose to reject supplied goods or services rendered. Human resources contracts also present a fertile ground for legal risks especially on termination.
Litigation usually arises from alleged violation of regulatory requirements or contractual agreements. Other litigants may include other aggrieved stakeholders such as local communities or competitors.
It is advisable to record the identified risks in a risk register for formalisation and completeness.
Risk analysis and evaluation
Identified potential legal risks should be analysed by assessing their likelihood and impact (consequence). Likelihood is usually measured in terms of probability or can simply be measured as high, medium or low. On the other hand impact or consequence can be measured in terms of severity such as financial consequences.
Risk evaluation entails using the results of risk identification and making decisions on the risk likelihood, severity and ways to manage the risk. A business will have to come up with risk management or treatment options. Some of the well- known options include:
- Accept or retain the risk if it is within tolerance or acceptable range.
- Avoid the risk by not doing what causes the risk.
- A risk taking business can in fact upscale the risky activities if the financial and other benefits are justified. Remember the higher the return the higher the risk.
- Remove the source of the risk, for example by simply complying.
- Change the likelihood of the risk, for example through having adequate controls or safeguards in agreements, processes, etc.
- Share the risk through for example insuring, subcontracting, joining hands with bigger or experienced suppliers, etc.
Examples of how to manage legal risks in business
The following are some of the practical ways to manage legal risks in business.
- Depending on its size a business may set up an internal legal and compliance function or outsource it.
- Adopt a risk management framework or system with the assistance of risk management experts. The ISO certification standards can be very useful.
- Document standard operating procedures (SOPs) for key functions exposed to legal risks such as procurement, marketing, production, human resources (HR) and finance. Line managers should have an appreciation of the labour laws, policies and procedures.
- Carry out due diligence on a party or parties before entering into contracts.
- Many disputes arise from verbal agreements. So document agreed positions preferably through signed contracts or agreements as close as possible to the date of agreement or decision. If delayed parties may be tempted to shift their positions with time.
- Where positions are agreed during meetings it is advisable to produce minutes which parties sign as soon as possible.
- Even writing letters or emails to confirm agreed positions can be useful in the event of a dispute. Remember disputes are resolved on the basis of evidence.
- Subject all contracts for review prior to signing. This can be done by internal legal resources or outsourced to a business’ commercial lawyers. A stitch in time saves nine. A properly drafted agreement can prevent disputes. In any case it is cheaper and easier to have a contract reviewed than try to assert rights or defend self in litigation.
- Conduct regular legal compliance health checks and address non-compliance.
- The legal function or resource person should keep abreast with changes in laws and advise management and the board. Alternatively, a summary of updates or legal opinions should be sought from the company’s lawyers.
- A business should have a documented system on how to deal with legal disputes or litigation. For example the business should be clear when to refer a dispute to its lawyers instead of having direct engagements with the other party.
Conclusion
It is imperative to management legal risks as the consequences can be disruptive or even dire. Being proactive will be cheaper and more effective than being reactionary.
Disclaimer
This simplified article is for general information purposes only and does not constitute the writer’s professional advice.
Godknows Hofisi, LLB(UNISA), B.Acc(UZ), CA(Z), MBA(EBS,UK) is a legal practitioner / conveyancer, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and is an experienced director of companies. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
