Managing litigation risk Part 1: stop disputes arising

It is an unfortunate fact of life that business activity generates disputes that may result in litigation or regulatory action.

Litigation is justifiably recognised as costly, unpredictable and inefficient - the antithesis of profitable business activity. However, litigation risk is not simply about legal expense. It is a broader issue which involves diversion of valuable management resources, reputational risk, brand damage and potential personal liability.

Over the next few weeks, we'll set out some clear guidance on how you want manage and reduce that risk. But of course prevention is better than cure. So, what can your business do to reduce the risk of a dispute in the first place?

Undue haste

Problem: Commitments are made on behalf of businesses before proper due diligence and contract review has been completed.

How to avoid this

Train key management and staff. Problems often stem from a lack of understanding about basic legal principles or applicable policies and procedures.

Set clear limits on delegated authority - while not fool-proof from a legal perspective, limits help in a number of ways.

Ensure your management team recognises the value of due diligence and contract review. These processes are not a deadweight but an investment that delivers tangible value to your business.

Incorporate a litigation risk review within your procedures for approving transactions and projects.

Unsuitable business partners

Problem: Businesses don't focus on counterparty risk before they enter into a venture or transaction.

How to avoid this

Ensure that you undertake due diligence on prospective counterparties before entering into a venture or transaction. A failure to undertake this task is a common root cause of many disputes.

Don't focus solely on financial or technical capabilities, but on the whole approach of the counterparty to doing business. Consider whether the counterparty's displayed behaviour aligns with your core values.

Don't take on a high risk counterparty inadvertently - active management may be required. Problems can be particularly acute where the arrangements presuppose a level of goodwill, or confer discretions that can be used as an effective veto or as a means to hold you to ransom. If need be, adjust structures or contractual terms to provide additional protection.

Contract management

Problems: Poor documentation triggers a dispute or regulatory investigation, or non-compliance with contractual requirements leads to a dispute.

How to avoid this

When negotiating, pay close attention to deadlines, performance standards, deliverables, termination rights, representations and warranties, indemnities, exclusion clauses and limitations on liability. These are common areas where disputes arise.

Don't sign documents without prior review by general counsel or external legal advisers. Use your own set of transaction documents where possible and regularly review them.

Don't be naïve about the level of self-interest counterparties may display when the going gets tough. Recognise the dangers associated with contractual provisions ending up in the drafting equivalent of the too-hard basket.

Don't scrimp on contract management. Establish adequate systems and procedures and ensure they are tailored to the specific requirements of each contract. Monitor and report on contractual compliance. Take particular care when identifying triggers for termination.

Misleading and deceptive conduct

Problem: Businesses are alleged to have engaged in misleading or deceptive conduct contrary to trade practices legislation.

How to avoid this

Update your trade practices compliance program. Train key management and staff on how to avoid misleading or deceptive conduct and the risks of non-disclosure. Ignorance is extremely risky when even honest but careless statements can lead to liability.

Implement systems to ensure that your business can justify representations, warranties and statements on which others may rely.

Ensure your risk management systems require pre-vetting and approval of all advertising and marketing materials.

Include appropriate disclosures and limitations on liability in transaction documents. 

New business activities

Problem: Businesses are blindsided by the risks associated with new products and ways of marketing or conducting business.

How to avoid this

Ensure your risk management systems require a legal review of all new products or services before launch. Explore potential regulatory issues arising from new ways of marketing or conducting business. There are often highly technical rules at work and traps for the unwary. Issues might include spam, privacy, IP and trade practices. Be thorough. Don't assume that there are no issues because of what other businesses are doing. Remember the importance of compliance with anti-corruption and bribery legislation when undertaking new business overseas.

Technological or regulatory change

Problem: Businesses are caught out by the speed of technological and regulatory change.

How to avoid this

Ensure your risk management systems require key risks arising from technological and regulatory change to be identified and proactively addressed.

Take advice from appropriate experts when required.

Prioritise cyber security and data breach risks which are hot topics.

Risk identification

Problem: Businesses don't focus on the risk of litigation and regulatory action despite these being significant risks to which each is exposed.

How to avoid this

Ensure that your audit and risk committee specifically identifies and addresses litigation risk. A cookie cutter approach is insufficient. It should evaluate and track exposure arising from key activities undertaken by your business along with each product and service that you offer.

Review your risk management systems to ensure that they identify and proactively address activities which create the potential for disputes, or expose your business to regulatory action, shareholder actions or class actions.

Consider adding legal expertise to your audit and risk committee if you do not already have it. Ensure that your audit and risk committee obtains input from experienced in-house counsel or external legal advisers when required.

Insurance

Problem: Businesses are forced to litigate over losses for which they could have obtained insurance cover.

How to avoid this

Conduct an audit or review of what cover your business enjoys for the risks to which it is exposed.

Ensure that your general counsel or head of risk management develops a good relationship with a competent insurance broker to ensure that the best possible tailored policies are purchased to suit the needs of your business.

Don't assume that cover is limited to public liability, product liability, PI and D&O. Keep abreast of new policies available in the Australian market, for instance, cyber risk insurance policies.

Assess whether your business would benefit from more specialised policies such as patent litigation insurance. Conduct a review of the terms of your policies as well as the risks covered.

Don’t review the insurance terms only when a claim is about to be made.

You can never guarantee that you will never have a dispute, but you can minimise the risk. In the next part of this series, we'll see what you can do if you are unfortunate enough to be in a dispute, and need to prevent it from escalating out of control.