Protecting your assets – minimising litigation risk
6th November, 2014
This article looks at different elements of litigation risk and provides a few ideas of what you can do to protect your business.
What is litigation risk?
Lawyers often speak of litigation risk as the risk that no matter how good your case is or how well prepared you are, there is always the possibility that things don’t go as planned on the day and you lose.
However, there is also the commercial issue of risk management, and particularly litigation risk management i.e. what are the chances of your business becoming involved in litigation?
Litigation risk in this context is the risk that court action will be taken or threatened against your business and you might suffer a loss as a result.
This could be a general risk as a result of the nature of the business e.g. trading with consumers in a highly regulated environment, or it could be a known exposure arising out of a particular transaction or contract which could give rise to concern.
Sometimes the risk is difficult to quantify or if it’s a risk arising from a particular deal then the value might be known.
Why do I need to think about it?
In operating a trading business, the key commercial issue is one of risk management.
Business risk can be managed in many ways including quality systems, regulatory reviews, insurance, credit checks, taking security for getting paid, recruitment and training of staff and, of course, contracting on known terms (and making sure those terms are fully incorporated into your contracts).
However, if something does go wrong there is the fear of high cost litigation with a low return process (you don’t always get full recovery and the management cost of dealing with litigation can be significant).
Where there is a specific litigation risk, there is a requirement to create a provision in the accounts of the business.
This is a requirement of both domestic and international accounting standards and exists so as to ensure that stakeholders or interested parties in a business have an accurate picture of the accounts.
It is worth bearing in mind that GAAP (Generally Accepted Accounting Practice) standards require a provision to be made at quite a low threshold if litigation is anticipated against the company.
Conversely, however, if there is a counter claim against the third party, that can only be included in the accounts if there is at least a 95% chance of success.
If a provision has to be made in the accounts, this could deplete the amount available for distribution as dividend, directors’ bonus, or if the company is listed there could be a requirement to make disclosures to the market.
Even aside from these obligations, it would be an uncomfortable meeting if, for instance, a five-year plan has just been agreed and signed off when an employee blew the whistle on a problem which had been left to fester for several years and which could cost the business millions of pounds!
Obviously before a risk can be provided for in the accounts, an assessment or investigation will need to be carried out so that a value can be placed on it.
Depending upon the nature of the business and/or issue, this might be carried out internally or even done by an external professional.
To properly assess the risk it will be necessary to think about:
- Nature of the issue and any commercial sensitivities around that either internally or externally
- Strengths and weaknesses surrounding the issue including any evidential difficulties. Is there an audit trail to prove the position you wish to take? Is there a smoking gun in the document?
- Risk of reputational harm
- Projected financial outcome (the cost of the issue itself and any legal costs attached to that)
- Key individuals – would you be in a worse position to deal with the issue if they left the company? If so ensure a statement is taken and signed ASAP. Retention of a key individual could be the difference between winning or losing a court action.
Often issues are brought to the surface as a result of an audit exercise or a business restructure.
When undertaking an audit, the auditors will wish to know all the facts around the issue to make sure a full assessment has been carried out and the proposed provision is justifiable and in line with accounting standards.
Auditors will be careful as they carry a risk themselves if they allow a matter to be under provisioned or misrepresented in accounts or disclosures.
Top tips for protecting your business
Even if there is no litigation on the horizon at the moment it is worth looking at the business and taking stock of whether there are weaknesses from a legal risk management perspective.
The tips below can help you maximise the chances of success and/or minimise the risk of failure if you do end up in litigation:
- Are your terms and conditions robust enough? Are there any areas which are frequently challenged and need to be tightened up?
- Do you have limitation of liability clauses in your terms and conditions? Limitation clauses can be for a fixed monetary amount or a percentage of the contract value. Seeking to limit liability or exclude to certain types of loss in your terms of business might assist favourably in negotiations with insurers.
- Who is able to sign contracts? What authorisation do individuals have to amend contracts, if at all? Do contracts have to be reviewed by a senior member of the management team before they can be signed off?
- What systems or procedures are in place if something does go wrong? Does the issue have to be reported to the Financial Director or legal department if one exists? Is there a minimum value on what has to be reported? Who reports to insurers? The last thing you want is a member of the team burying a problem which later comes back to bite you.
- Your insurance policy will provide that you must not take any steps if a claim is received without seeking their consent first. If you become aware of circumstances and fail to notify the insurer, you face the risk of your insurer seeking to avoid the claim.
- Does your insurance cover match up to the business actually being carried out? Business models change over time so its important to ensure that the right cover is in place to match the business activities and the value of those activities.
- Do you have a document retention policy? Once a claim or a dispute has arisen you have a legal duty to preserve all documents and information relevant to that dispute (including electronic information and voicemails). However, even before you know about a dispute, its worthwhile making sure that information is held for a reasonable period of time (depending on the nature of the information this could be a statutory requirement). What if a customer complains he didn’t receive the goods or service he paid for but you find all the paperwork has been destroyed so you can’t prove what the customer signed up to?
- Bear in mind that if you do end up embroiled in Court proceedings all relevant emails, documents and correspondence are discloseable. We have seen so many emails which, whilst not directly damaging, are unprofessional and present a certain image of the sender especially when viewed in the cold light of day.
- Are your company policies up to date? How is customer or employee data to be used? Are staff up to date in their area of expertise? Is there an induction policy for new recruits? If these things do exist and something goes wrong at least you can demonstrate that you have taken all reasonable steps to comply with the law.
Every business and every problem is different so it’s impossible to cover all scenarios here.
There will be many others which are particular to your business sector on which we would be more than happy to talk to you about.
If you wish to discuss any aspect of this article, please do not hesitate to contact Julie Huntingdon.
Please note that this briefing is designed to be informative, not advisory and represents our understanding of English law and practice as at the date indicated. We would always recommend that you should seek specific guidance on any particular legal issue.
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