MANAGING LEGAL RISK WHEN OPERATING A BUSINESS
General
I am hopeful that you now have a good understanding of some of the major legal issues
relating to the conduct of business. What I would like to do now is place all of this
information in a context that will result in its most efficient use.
It has always been my opinion, as a lawyer, that I do more good by advising a client
about legal issues before they have become a problem for the client. I call this the
proactive practice of law as opposed to the reactive practice of law. I’m a firm believer
of the well known saying that “an ounce of prevention is worth a pound of cure.”
In relation to law and knowing your rights when in business, no truer words can be
spoken. You will be astonished at what you can end up paying to have a lawyer help you
out of a serious legal problem. In this regard, I’m reminded of the painting that describes
a lawsuit. It shows a cow that is being pulled by the tail by one client and pulled by the
nose by another client, with the two lawyers in the middle milking the cow. That might
be funny, but if you should ever become one of those clients, I assure you, you will not
be laughing. Lawyers get very used to having unhappy clients. They come to realize that
many clients just see them as necessary evils and don’t take it personally. In other words,
you can hate me, just make sure you pay me!
So that you don’t get caught having to pay a large legal bill, you want to minimize your
contact with lawyers and you want to ensure that most of your contact with them is in
dealing with preventive maintenance. Think of your business as a car and the mechanic
is the lawyer. A little bit of rust proofing now, saves you a lot of money and hassles
down the road.
Assessing the Legal Environment
When you’re in business, many of you now understand that you have to plan. You need
systems in place that deal with operations, marketing, human resources, finances and all
that other management information. However, any business that wants to be successful
in the long term also needs to deal intelligently with the legal environment. By doing so,
the business is less likely to make mistakes that are:
-debilitating in terms of legal fees and damage claims
-likely to distract in terms of time and effort away from the business
-detrimental to its goodwill
The Legal Risk Management Plan
A legal risk management plan is a comprehensive plan that addresses the legal risks
involved in operating a business. It is different from most other types of planning that
have as their goal the creation of revenue. The legal risk management plan is focused on
reducing possible future expenses of a legal nature. As noted above, these would consist
of damage awards, lost opportunity costs, loss of goodwill and legal fees.
This type of plan is very commonplace with larger businesses that have the necessary
resources in terms of skill, time and money and that also appreciate the importance of this
kind of planning. Unfortunately, many smaller businesses do not even think of having a
serious legal risk management plan. The small business owner will often ignore legal risk
because putting any time into this area costs money and takes time away from revenue
generating activities. Many small business owners just don’t think it is worth their while
to invest time and money into a plan that will only cost money rather than make it and
that will only end up protecting against risks that are only contingent in nature.
I think this is a big mistake for any business owner who has any intention of being in
business for the long term. It is also indicative of a very superficial and ill-informed
understanding of the nature of legal risk and the fairly straightforward methods of
managing it.
Creating a Risk Management Plan
Creating an RMP is a four-step process:
1-Identify the legal risks
2-Evaluate the potential loss associated with those risks
3-Devise a legal RMP to address those risks
4-Implement the plan
Using the Four-Step Process
1-In order to identify legal risk you have to
a-Assess the organization’s functional areas
b-Review the organization’s business decisions
c-Determine the parties with whom the organization has a business relationship.
In order to do a good job with this step, you have to know some law or you have to know
what you don’t know so you can then determine when to get some legal advice. In my
opinion, this is why you take a business law course.
The functional areas of an organization are, for example, marketing, finance, operations,
human resources, IT. All of these functional areas are subject to their own types of legal
risk. Marketing, for example, is subject to tort law, industry codes and government
regulation regarding marketing representations. Sales will require a knowledge of
contract law. Operations will be subject to health and safety regulations. HR will face all
kinds of issues relating to employment law. All of these risks have to be recognized and
understood.
Reviewing business decisions can also identify a business’s legal risks. For example,
how is credit granted or obtained; what terms are contained in standard form contracts of
the business; how does the company control its inventory. There are all kinds of other
decisions that a business must make in order to operate and they generally tend to have
legal consequences. They should all be reviewed on a regular basis and understood.
Assessing the business’s relationships will allow the business to determine which ones
create legal risk. For example, every customer is a potential legal risk if they do not pay
you or if one of them slips and falls at your business because you did not keep it clean.
This first step of the RMP may look a bit too negative because it seeks to identify
everything that can possibly go wrong in a business operation. However, it’s actually
very realistic and results in a comprehensive review of the potential downside of doing
business, with a view towards minimizing loss.
2-Once you’ve identified the legal risks, you have to figure out what the loss could be if
these risks turn into actual problems. This involves assessing both:
-
the probability of the loss, and
the severity of loss.
For example, you can have a legal risk that will probably never happen but if it does
you’re in huge trouble (your factory burns down). Conversely, you can have a legal risk
that could probably happen but will have very little impact in terms of loss (a small
customer that owes you money goes bankrupt). Then there are all the risks in between
these two extremes.
Sometimes it is very difficult to figure out these issues as not all risks are alike, nor
should they be treated alike. It will often be necessary to retain the help of experts to
advise you on these matters.
3-Once steps 1 and 2 have been completed, you can then devise the RMP. This basically
involves doing a cost-benefit analysis in regard to the identified risks and how to deal
with them. There are basically four options at your disposal:
a-Avoid or eliminate the risk. This should be done when the risk is simply too
great or when the benefit from the activity that creates the risk is less than the cost
if the risk from the activity actually materialize. For example, you run a winter
backpacking operation and the forecast for the winter is wet snow that is very
conducive to avalanches. You may decide suspend all expeditions for the time
being
b-Reduce the risk. This means implementing practices in a business to lower the
probability of loss and its severity. For example, when extending credit to
customers the business should have policies in place to ensure, as best as possible,
that the risk of doing so is minimized (credit checks, quarterly evaluations etc.).
Another example would be having a schedule in place pursuant to which your
staff regularly checks the floor of the produce department to make sure it is not
slippery (you run a grocery store).
c-Retain the risk. This may happen when it has been determined that the risk and
its consequences can be survived and the cost of insurance is just too high. This
is called being self-insured because you believe that your business has the
resources to pay for any loss without this causing too much harm. You want to be
careful with this one. Retaining risk should not be a gamble. It is not even a
calculated risk. It should simply be a sound business decision.
d-Transfer the risk. This just means transferring the financial risk associated with
a particular activity to another person by contract. In other words, you insure the
risk. This is usually the best response to managing the risks associated with your
business. However, it can often happen that the cost of a particular type of
insurance is too high (employee theft), or a particular risk is really difficult to
insure (environmental contamination). Furthermore, insurance does not prevent a
loss or the possible adverse consequences and damage to reputation of a liability
case. So don’t think of insurance as the answer to all of your legal risk
management problems. It should only be one of several methods you might use
to create a good RMP.
There are also other ways in which the legal risk can be transferred. For example,
an exemption of liability clause in your standard form contract is a way to transfer
legal risk. Such a clause can result in a reduction or elimination of liability in
relation to customers by detailing that you cannot be held liable for damage
caused by you to one of your customers. The key with these clauses is finding a
sensible balance between the protection of your interests and the possible wrong
impression the clause will leave with your customers. Too broad a clause that
may eliminate any liability for your business may end up losing you a lot of
business if customers are turned off by it.
4-Once you have devised your RMP, you have to put it into action and assess its
effectiveness on an ongoing basis. In order for this to be done properly,
responsibility for implementation must be clearly assigned within your
organization. As well, communication and education must take place. Your staff
must not only be made aware of the RMP but they must also understand it.
Depending on the complexity of your business, you may have to create written
manuals to be followed by your staff in order that implementation of the RMP is
done consistently.
The plan should undergo a review as often as is reasonably necessary given the
nature of the risks that it is protecting against.
Reacting when Prevention Fails
Unfortunately, it may happen that in spite of a comprehensive RMP, your business may
still get itself into legal difficulty. This is just a cost of doing business and the reason
lawyers stay in business.
You must have a good understanding of how lawyers operate and what the legal system
can and cannot do for you. You need to have a plan that deals with how you will react to
a legal problem. Far too many business owners call the lawyer the minute they think they
are in legal jeopardy. This is not a good idea as a planned reaction. Your first order of
business is to do your own personal assessment of the situation. Many legal problems
can be dealt with by the businessperson herself, especially one that has good experience.
The experienced businessperson has usually acquired a good deal of legal knowledge
along the way and at the very least has a good idea of when she should call the lawyer
and when the lawyer can be ignored. Trust me, acquiring this type of experience will be
invaluable to you as you progress in the business world.
If the problem is serious enough to get the lawyer involved, I strongly advise you to do
the following:
-Even if you have a regular lawyer, make sure you choose a lawyer that has
sufficient experience in dealing with the legal problems that are similar to yours.
-As soon as possible, get a really good handle on the economics of the problem.
No point in being right from a legal point of view, if it’s going to cost you a lot of
cash to prove the point. Stress this point with the lawyer.
-Make sure you have a clear understanding of what your lawyer is telling you and
how much it is going to cost you for the information. Get the payment issues
agreed to right away and get them in writing.
-Make sure you clearly understand what your lawyer is doing for you and
conversely what you may have to do in regard to resolving the problem. I’ve seen
it happen far too often that communication between client and lawyer is confused
and results in a misunderstanding that impacts negatively on the resolution of the
issues.
-Keep documented evidence of everything. A lawsuit or any type of legal
problem can become a totally confusing and paper intensive exercise. Stay on top
of it and provide clear and relevant information to your lawyer. It’s not about
being right or wrong it’s about what you can prove.
-Tell your lawyer the whole story. You are fooling yourself if you do anything
but.
-Always keep an open mind about settling whatever problem you have, rather
than dragging it on and going to court. This means you should focus on the
economics of the problem and also how it may be adversely effecting your
business by keeping you preoccupied. While it may be very difficult to settle a
legal problem by taking less than what you should get or by giving more than
what you feel you have to, it can often beat the heck out of suffering through a
lengthy problem only to be in a worse position by the end of it.
We can discuss these issues further in class.