Legal risk and corporate counsciousness

By Taqyuddin Kadir

I would like to share an article on risk management which is provided below along with my brief comments on each paragraph. The article was written by Gary Head who was professions underwriting director at Hiscox, quoted from www.managementconsultancy.co.uk

Gary Head starting his article with an interesting statement; "This might come as a shock but the truth is that you don’t have to have done anything wrong to receive a solicitor’s letter demanding compensation".

In relation with the factors potentially influence a client to be reluctant to pay a consultant who has delivered services, Gary Head stated that, "a change of management, corporate financial difficulties, boardroom politics or simple greed can all result in clients not wanting to pay a consultant for delivering advice, service or a system, and looking to a solicitor to help them". Eventhough Gary Head's view in this paragraph only focused on consultant interest in term of legal risk, I think the analysis is also relevant with other suppliers interest.

In discussing on risk management, Gary Head provide clear desription in the following paragraph:

"the first and, most important ingredient of effective risk management is corporate consciousness. The risks and potentially disastrous effects have to be fully appreciated at board level. For a culture of risk identification and reduction to permeate a business, the lead has to come from the very top".

In relevance with Gary's statement above, I can't deny the fact that there are many top managements of companies who are not aware about legal risk. Many of them who regard business contract, for example, more just as paper works formality that symbolizes the closing of deals rather than as a legal instrument for their legal interest protection or as part of legal risk management. They even regard compliance with the relevant regulatiories is optional instead of oblgiatory. However, smart top executive normally assigned an inhouse-lawyer or external lawyer to oversight any legal risk which potentially affect their business operation, and this done integratedly with the operational management. Relevant with this, Gary Head described the following:

"It is no coincidence that leading companies have a risk management function at the executive level, often backed up by a large internal legal team. For smaller businesses, the practical effect of litigation can be even more crippling and it is essential for business owners to take it seriously. Many consultants have said to me ‘it could never happen to me’ or ‘my client is a personal friend and would never dream of suing me’. The first step in effective risk management is to accept that risks really do exist".

The problem is that, a lot of people do not believe anything they have not experienced. Experience is the best teacher, isn't it. So, legal risk for them might be something useless to think about, because it has not yet been experienced by them. Smart example as way out of this issue is provided by Gary Head as follows:

"For example, it is generally accepted by the scientific community that one day an asteroid will collide with the Earth. What we don’t know is where and when it will hit, or what it will look like. The likelihood of this happening in the next 50 years may be very low, but the risk still exists. Once a consultant accepts that risks do exist, the next practical step is to identify the risks facing the business. To be effective and avoid or reduce the big loss you will never know about, this needs to be an ongoing process and eventually part of your business culture".

Risk can be viewed from two perspectives. From the negative perspective, risk is probability of loss, but from positive perspective, risk is opportunity for benefit ? Is this relevant with legal risk ? What if the risk that is resulted from non-compliance with regulatory ? Is there any benefit in it in the form of compliance cost cutting ?

"To identify such a culture in practice, imagine a consultant negotiating a new piece of work with a sophisticated client who includes a clever penalty clause in the contract. If the consultant can confidently bring this to the attention of the consultancy’s legal or management team (despite the possibility of it leading to the loss of the work), then the firm will have successfully developed a risk-conscious culture".

That 's the point, risk-counsciousness culture. But you can't build up your risk counsciousness without having sufficient information or knowledge on the risk itself. In the case of legal risk, legal awareness and literacy are conditio sine qua non for risk consciousness culture establishment.

"Another key area where careful risk management can save thousands of pounds is complaint and contract management. For example, does every person in your firm know how to respond to and escalate complaints? An assumption that complaints will go away or somehow sort themselves out can lead to disastrous delays and, more importantly, prevent the problem being resolved quickly and efficiently. And don’t forget, criticism from a client is not always something that a consultant wants to tell their manager about".

Delay of services is very crucial to avoid from if you don't want to take risk of being left by your clients.

"When looking at the risks facing your business, you need to consider physical risks (such as property damage and bodily injury), financial risks, credit risks, reputational risks and any other type of risk that might affect your business. You know your business better than anyone else and are best placed to identify weak spots. Once you have identified a comprehensive list of risk types, you need to quantify the potential impact to the business, both in terms of the likelihood of it happening and the possible outcome if things go wrong".

Good analysis and identification of risk is part of risk management.

"In the case of the asteroid hitting Earth, the probable outcome would be total devastation, but the likelihood of occurrence is so small, based on our current knowledge levels, that we can discount the risk."

But, who could pre-calculate the risk of 9/11 before it happened ? Why now we are more cautious of the probability for its re-occurence compared to the time before it happened. Do you think that the chance of the second 9/11 to re-happen is big. What is the trigger ?

"For tangible risks with a material chance of occurrence ­ for example, default by your clients ­ the next step is to minimise the risk. Tightening up payment terms or increasing the frequency of payment chasing are practical steps you can take. Most risks are capable of being reduced or managed, but very few can be removed altogether. For this latent exposure, the final step is to consider ‘effective risk transfer’ ­ removing the potential impact from your balance sheet and putting it onto someone else’s".

Risk transfer is of course part of risk management as well.