Australia: Integrated legal risk management - Opportunities for the transport and logistics industry part 2

Last Updated: 11 December 2011
Article by Randal Dennings and Wei-Loong Chen

Key Points:

Legal risks are usually considered to be just one of the types of risk an organisation has to manage, but there are some key differences relevant to legal risks.

In part 1 we looked at how a legal risk management program (LRMP) can operate within an organisation's governance, risk and compliance (GRC) framework, and identified the components of an effective LRMP.

We will now look at some practical steps that organisations could take in managing their legal risks. Before we do so, it is useful to examine what is meant by a legal risk.

How to think about legal risks

Legal risk is generally defined to be the risk of an organisation failing to meet its legal obligations. Legal obligations can arise from legislation, contracts, licenses, permits, court decisions and industry codes of conduct.

  • In the transport and logistics industry, legal risks can arise from:

  • land, sea or air transportation legislative requirements;
  • occupational health and safety legislation;
  • environmental protection legislation;
  • employment arrangements;
  • competition law; and
  • the provisions in client contracts.

Legal risks generally manifest themselves in fines, court proceedings, regulatory enforcement and contractual breaches.

Legal risks are usually considered to be just one of the types of risk an organisation has to manage, but there are some key differences relevant to legal risks.

Ordinary risk management techniques usually consider the legal consequences of an event (such as potential penalties, contractual damages and regulatory action) as a factor in determining the severity (or risk impact) of that event occurring.

For example, if penalties for a failure to ensure personnel are trained to safely operate heavy vehicles (which some might consider an operational risk) are significant, an organisation could very likely consider a "failure to train drivers" to be an operational risk which it needs to manage. It would then put in place controls to manage the operational risk (and the related legal consequences).

While there is no issue with this approach, legal risks need greater focus by organisations for the following reasons:

  • a legal risk in itself can be an event (for example, a decision by a company to agree on transportation charges with competitors in breach of the Competition and Consumer Act 2010 may not be triggered by any other event);
  • one legal risk can trigger another (in the above example, cash flow risk due to the payment of a significant fine could result in breach of financial covenants under the organisation's loan facilities); and
  • it can trigger other non-legal risks (in the above example, a significant fine for price fixing could trigger cash flow risks, and the dismissal or imprisonment of the relevant employee could result in personnel risk).

As discussed below, the severity (or impact rating) of a risk is determined by the organisation's assessment of the likelihood of the risk occurring, and the consequences of the risk occurring.

It is also important to understand that with legal risks the consequences are often pre-determined without much flexibility for alteration. For example, the consequences of statutory breaches are usually specified in legislation, and consequences for contractual breaches may be specified in the relevant contract document.

The usual risk management techniques for minimising or reducing consequences may not always be appropriate for legal risks since the consequences for legal breaches can often be decided by external entities - for example, courts, regulators and legislative bodies.

Given that the consequences of legal risks are fixed, the key then to reducing the impact of legal risks would be to minimise the likelihood of the risk occurring (ie. preventing the occurrence of the legal risk).

Having said that, in considering the likelihood of a risk occurring, organisations should be aware that for legal risks, a reduction in likelihood may not necessarily reduce the consequences of legal risk. For example, a breach of the cartel conduct prohibitions once every three years carries the same potential penalties in the Competition and Consumer Act 2010 as a breach once every ive years.

How do you manage legal risks?

In most instances, an organisation's existing risk management framework can be appropriately used to manage legal risks. We have observed that most organisations have developed their risk management frameworks in accordance with the ISO standard for risk management programs, ISO 31000:2009.

In using this or a similar framework, it is important to be aware of the unique nature of legal risks (as explained above and below).

We suggest the following series of continuous steps for the management of legal risks, based on the risk management methodology set out in ISO 31000.

Step 1- Establishing the context

Establish the internal and external context in which the organisation's legal risks are to be considered. This involves asking, for example:

  • what are the organisation's activities?
  • what is the organisation's corporate structure?
  • what laws apply to the organisation?
  • in which jurisdiction(s) does the organisation operate?
  • who are the organisation's key regulators?
  • what licences or permits are critical for the organisation's continued existence?

Step 2 - Identifying legal risks

This involves identifying the legal risks applicable to the organisation. As part of Step 2, you will need to consider whether the organisation would take a narrow (just legislation) or an expansive view (legislation, contracts, industry codes and other sources of legal obligations) on legal risks. It is also useful to consider the number of legal risks the organisation wishes the LRMP to address - for example, the top 10 or 20 legal risks.

Step 3 - Analysing legal risks

This involves assessing the likelihood and the consequences of the legal risk occurring, so as to determine the inherent severity (or impact rating) of the legal risk.

The organisation's existing risk likelihood and consequence tables can usually be used to analyse legal risks and to determine the inherent impact rating of legal risks (for example, into low, medium and high inherent risk ratings).

Step 4 - Risk evaluation

This involves evaluating the risks analysed in Step 4 against the organisation's risk appetite to determine which risks need to be prioritised for further focus and management. (Risk appetite can be broadly defined as the amount of risk an organisation is prepared to accept in the pursuit of its objectives.)

Any risks which are deemed to exceed the organisation's risk appetite will need to be further examined and addressed.

Step 5 - Risk treatment

This generally involves putting in place measures and controls to reduce the inherent risk impact of a risk to an acceptable residual level, in line with the organisation's risk appetite.

A frequent question is to what standard should legal risks be managed. Given the nature of legal risks and often pre-determined consequences for legal breaches, the aim of legal risk management is to prevent legal breaches from occurring in the first place.

Organisations with best practice legal risk management approaches usually adopt a zero-tolerance policy on legal risks.

From a legal perspective, zero tolerance may be defined to mean meeting a legally defined standard or exceeding it. Zero tolerance does not mean that the LRMP has to operate perfectly all the time to eliminate all breaches in order to adequately protect the organisation,[1] but we suggest that performance benchmarks for the LRMP should be set sufficiently high in order to be effective.

Many organisations report that they already have zero tolerance policies in place for their key activities and in many cases zero tolerance policies are aimed to exceed mandated standards. For example, zero tolerance policies are often set for workplace injuries and fatalities, fraud, product safety and contamination.

From a risk management perspective, a target residual risk rating of "low" would be consistent and appropriate with a zero tolerance approach to legal risk.

Step 5 then involves putting in place the appropriate measures to seek to achieve a low residual risk rating for identified legal risks. For certain legal risks, it may be that it is not possible to achieve a low residual risk rating - this is acceptable, provided senior management and the Board are made aware of and approve the risk.

Step 6 - Monitoring and review

This involves regular monitoring and review of the organisation's risks as identified and evaluated in the above steps to ensure that the organisation's assessments and controls remain valid and effective.

Step - Communicate and consult

Step 7 effectively brings the cycle back to Step 1, where the organisation starts the legal risk management process again by consulting with stakeholders about the internal and external context in which the organisation's legal risks are to be considered and managed.

Conclusion

Legal risk management has become an increasing area of focus for Boards and senior management.

As with any significant change program, there are always challenges to be overcome in implementing an organisational LRMP and to proactively address legal risks, but organisations with best practice LRMPs report that they have found the journey worthwhile.

Significantly they have formed this view, not only from a GRC perspective, but from their discovery that these projects have also delivered significant organisational efficiencies and performance benefits.

In the longer term, these organisations have reported a greater business resilience when dealing with their legal risks.

Footnote

1 For example, most statutory due diligence defences are framed around principles of taking "reasonable steps" or acting in a "duly diligent" manner to prevent a breach, rather than a standard of taking all possible steps to prevent a breach.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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Authors
Randal Dennings
 
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