With that in mind, having a trusted legal advisor will be one of your best assets. Basel II classified legal risk as a subset of operational risk in 2003. This design is based on a business perspective and recognizes that there are threats in the business environment. The idea is that companies don`t operate in silos and tend to be subject to legal obligations when they take advantage of opportunities and engage with other companies. [1] If you`re an investor or a company, you`ve probably heard that you should always comply with employment law, tax law, and other regulations. One of the most obvious legal risks of not doing so is the risk of arrest and prosecution. Legal risk was defined as part of operational risk by Basel II in 2003. It involves the risk of financial or reputational loss arising from any type of legal problem. This could include a lack of awareness or understanding of how laws and regulations apply to a business.
But companies can take steps to reduce this risk. For example, a company may require all employees to complete health and safety training to reduce the legal risk associated with claims. Many countries restrict foreign ownership of assets and legally require foreign companies to enter into a joint venture with a local partner to do business there. Poland, for example, restricts foreign ownership of farmland and will continue to do so for another decade under agreements with the EU.2 A company`s financial performance and related accounting can present recurring risks for potential litigation. For example, when shareholders are dissatisfied with a company`s profits in a given quarter or over a long period of time and believe that management is responsible for their actions or inaction. If a company has to restate its profits due to an error or deliberate misrepresentation of material matters affecting the company, shareholders can sue the company for failure to disclose. For better or worse, government regulations infect every sector of the economy. These regulations set standards of care, requirements, require reports and presentations. With each regulation, the risk of fines, penalties or injunctions increases to promote compliance.
Regulatory risks are inevitable and potentially embarrassing. Below are some of the types of legal risks a company should consider when creating a legal risk management framework, as well as some strategies to address them if they arise. These are the risks arising from the regulations and laws that govern a commercial organization or the market in which it operates. Each country and the government establishes certain laws and regulations for the proper functioning of businesses. And all companies must comply with these rules and regulations of the country. In addition, any non-compliance can have serious consequences for any organization. For example, a company may face severe penalties and even closure if tax regulations are not followed. Each organization must ensure that it complies with all possible rules and regulations of the government and the legal bodies that regulate them. It should respect the laws and statutes of the country in order to minimize the possibility of legal risks. Given the various potential sources of litigation risk, listed companies must include provisions in their budgets to cover their legal expenses in accordance with generally accepted accounting principles (GAAP) and international accounting standards. Legal risk management begins with identifying potential threats that could result in the loss or disruption of your business and allows you to implement processes to minimize or nullify them. In general, all the laws of the host country apply to an entrepreneur`s local business activities.
Examples include registration procedures, labor law, environmental law, tax law, and property requirements. The World Bank has a fairly comprehensive library on the country`s business law, accessible from its website. This can be useful in the initial phase of assessing the legal impact of direct investment in a given country. Holding large amounts of data makes companies a tempting target for hackers. A data breach carries a serious risk of litigation and potentially hefty fines for non-compliance with Australia`s reportable data protection system. Legal risks may result in fines and administrative penalties, the need for monetary damages, reputational deterioration, deterioration of the bank`s market position, restriction of development opportunities, reduction of development opportunities or legal enforcement of agreements. There are risks that can arise for a company to be part of a contract with a third party. A competitor may infringe an organization`s patents and copyrights or launch a product similar to the one offered by a company.
The situation can also be reversed. Other companies may take legal action against a company. This can be for issues such as trademarks, patents, and copyright infringement. Legal risk management is not a precise and subjective science to the situation of the institution and is mainly caused by the absence of an appropriate communication channel, undefined institutional objectives (such as the absence of policies and regulations), an unclear flow of information between different employees and departments, a lack of delegation of authority to define risk mitigation tasks. [7] The scope of competences beyond national borders varies considerably. In antitrust law, for example, US law only covers situations where the breach affects the US (meaning that it does not matter where the act that caused the breach occurred), while the EU only considers the place where the antitrust crime was committed.3 There are four types of legal risks. Legal risks arise from contracts, regulations, litigation and structural changes in the market. Risk is anything that makes the outcome of an event uncertain and detrimental. Legal risks are the risks to which a commercial organization is exposed and which are related to legal issues. This type of risk is usually the result of non-compliance with laws, rules, and regulations of the government and other legal entities that control companies. Various issues that may give rise to legal risks include commercial contracts and agreements, related assets and disputes, issues relating to intellectual property rights, patents, copyright infringement, etc. Legal risks can cause monetary and non-monetary losses to a business.
Monetary losses include business losses due to the cancellation of orders or the payment of damages to external third parties. Non-monetary losses include loss of reputation, goodwill, or damage to the company`s brand value. Costs and income foregone caused by legal uncertainty multiplied by the possibility of the individual event or the legal environment as a whole. [10] One of the most obvious legal risks in the conduct of business, which is not mentioned in the definitions above, is the risk of arrest and prosecution. This is the potential loss that a business or individual could suffer due to a legal issue. This may include a claim against them, a change in the law, or a failure to take appropriate legal steps to protect themselves. The legal department of a corporate organization must ensure strong and ethical corporate governance within the organization. It should ensure that the company conducts ethical and legal transactions and practices that minimize legal risks.
Employee behavior, intellectual property, business practices and more lead to lawsuits. The risk of litigation receives the lion`s share of media and board attention. Litigation is not necessarily the most damaging legal risk. Compliance risks are the risks related to the various compliance risks to which a company is subject. This correspondence may be related to internal policies and practices. These may include policies and legislation external to government and other legal bodies. Legal risk is the likelihood of financial loss or loss of reputation resulting from a lack of knowledge (or misunderstandings) about how the law will be applied to your business, or working with reckless indifference to the law and its enforcement. They work hard to ensure that your business is profitable and maintains an excellent reputation. Don`t risk this by losing sight of all the legal risks associated with running a business. Your approach to risk classification should be tailored to your organizational context.
We will not mention the overlapping classifications for the most part, except to say that risk reporting in overlapping categories can lead to a successful identification of risks that is more important than the classification itself.