risk

RISK IN LEGAL RISK IN LEGAL CONTRACTSCONTRACTS

APURVA AGARWALAPURVA AGARWAL

PARTNERPARTNERUNIVERSAL LEGALUNIVERSAL LEGAL

August 14, 2009August 14, 2009

PREDICTING AND MITIGATING LEGAL RISK THROUGH ACTIVE

RISK IDENTIFICATION WHILE STRESSING ON EFFECTIVE RISK

MANAGEMENT EFFORTS

Nothing is pervasive like law as a person, whether natural or

artificial, is governed by law right from birth to death.

RISKRISK

DefinitionDefinition hazard: hazard:

a source of danger; a source of danger;

a possibility of incurring loss or a possibility of incurring loss or misfortune misfortune

Types of Types of Risk - Risk - BusinessBusiness

• FinancialFinancial• PoliticalPolitical• FidelityFidelity• LegalLegal

Legal Risk…..DefinitionLegal Risk…..Definition

Oxford Oxford DictionaryDictionary

as a chance or probability of as a chance or probability of danger, loss, injury or other danger, loss, injury or other adverse consequenceadverse consequence

Legal ParlanceLegal Parlance peril, hazard or chance of lossperil, hazard or chance of loss

Common Common UsageUsage

a chance of encountering a a chance of encountering a situation in which one has to suffer situation in which one has to suffer loss or injuryloss or injury

RISK EXPOSURERISK EXPOSURE• Business organizations

Governed Applicable LawsApplicable Laws

Business RelationsBusiness Relations

ExposureExposure Legal RisksLegal Risks

Contractual RisksContractual Risks

Minimized Minimized Well tailored risk treatment plans

Kinds of Legal RiskKinds of Legal RiskOrganizational Organizational Legal RiskLegal Risk

•Associated with maintenance of the Associated with maintenance of the companies assets and propertycompanies assets and property

•Internal affairs of the CompanyInternal affairs of the Company

ExampleExample •failure to protect its intellectual failure to protect its intellectual property assets property assets

•shareholders decision contrary to shareholders decision contrary to the decision of the management of the decision of the management of the company the company

Kinds of Legal RiskKinds of Legal RiskLegal Legal Methodology Methodology RiskRisk

•methods adopted and steps taken to methods adopted and steps taken to protect the company’s assetsprotect the company’s assets•protection against protection against claims by others claims by others liability to pay compensationliability to pay compensation

ExampleExample the company does not take warranties the company does not take warranties from its counterparty, but relies instead from its counterparty, but relies instead on its due diligence procedures on its due diligence procedures

Kinds of Legal RiskKinds of Legal Risk

Operational Operational Legal RiskLegal Risk

Obligations or liabilities that were not Obligations or liabilities that were not foreseen, or are greater than were foreseen, or are greater than were foreseenforeseen

ExampleExample The possibility that contractual rights will The possibility that contractual rights will be void or unenforceable due to:be void or unenforceable due to:•illegality;illegality;•a technical defect (e.g. lack of restriction a technical defect (e.g. lack of restriction or registration);or registration);•lack of capacity (of either party );lack of capacity (of either party );

LEGAL RISK….ContdLEGAL RISK….Contd

Risk suffered by Companies Risk suffered by Companies

Two Types of Loss/ Injury Two Types of Loss/ Injury

PecuniaryPecuniary

Loss Loss

• DamagesDamages• Borne by CompanyBorne by Company

CorporealCorporeal

Loss Loss

• ImprisonmentImprisonment• Borne by DirectorsBorne by Directors

Legal Risk….ContdLegal Risk….Contd

ReasonsReasons ExampleExample

Contractual Contractual provisions provisions unenforceableunenforceable

Contract for ProstitutionContract for Prostitution•Unenforceable in India / Unenforceable in India / Middle East CountriesMiddle East Countries•Enforceable in AustraliaEnforceable in Australia

Legal Risk….ContdLegal Risk….Contd

Contractual Contractual Provisions Provisions inadequately inadequately drafteddrafted

Liabilities of parties not Liabilities of parties not documenteddocumented

Obligations Obligations of the Parties of the Parties ambiguousambiguous

•A agrees to sell 10 mtrs ofA agrees to sell 10 mtrs of

clothcloth•No description of clothNo description of cloth

LEGAL RISK….ContdLEGAL RISK….Contd

ResponsibilityResponsibility •CompanyCompany•Officers In Charge – conduct of Officers In Charge – conduct of the affairs of the companythe affairs of the company

OffenceOffence •Civil i.e. compliance defaults, Civil i.e. compliance defaults, breach of contract etc or breach of contract etc or •Criminal i.e. cheating, breach of Criminal i.e. cheating, breach of trust, fraud etctrust, fraud etc

Kinds of Legal RiskKinds of Legal Risk

Product liability Product liability Employee liability Employee liability Compliance defaultCompliance default Tax compliance Tax compliance EnvironmentalEnvironmental IPRIPR

Product Liability RiskProduct Liability RiskAssociationAssociation • Final productFinal product

• Arising from the performance of the Arising from the performance of the spare parts or componentsspare parts or components

Minimized Minimized by by

• Inserting proper Liability limitation Inserting proper Liability limitation ClausesClauses• Limiting liability of the manufacturer Limiting liability of the manufacturer and fixes the liability on the sub-and fixes the liability on the sub-contractors.contractors.

Example Example • Manufacturing Companies - ExposedManufacturing Companies - Exposed• Minimized by outsourcing the workMinimized by outsourcing the work

Management Liability RiskManagement Liability RiskAssociationAssociation •Deduction and payments of employee Deduction and payments of employee

welfare statutory dues like provident welfare statutory dues like provident fund, ESI contribution, bonus, gratuity, fund, ESI contribution, bonus, gratuity, wages etcwages etc•Company held responsible for the act of Company held responsible for the act of its employees/directors/managersits employees/directors/managers

Minimized Minimized ByBy

•Execution of proper Employment Execution of proper Employment contractcontract•Statutory compliances like labour lawsStatutory compliances like labour laws•Limiting liability of the Company for the Limiting liability of the Company for the acts of its employees/ directors/ acts of its employees/ directors/ manager.manager.

Management Liability Management Liability Risk….ContdRisk….Contd

• Case LawCase Law

Arthur Arthur Anderson Anderson CaseCase

•Enron a US Company accounts were “WINDOW Enron a US Company accounts were “WINDOW DRESSED” show a healthy financial position. DRESSED” show a healthy financial position. Filed for bankruptcy in December 2001.Filed for bankruptcy in December 2001.

•Andersen - internal and external auditor of Andersen - internal and external auditor of Enron since the mid-1990sEnron since the mid-1990s

•Security and Exchange Commission (SEC) Security and Exchange Commission (SEC) investigating various charges against Enroninvestigating various charges against Enron



•The DOJ, found Andersen guilty of obstructing The DOJ, found Andersen guilty of obstructing SEC's proceedings. SEC's proceedings.

•The SEC revoked Andersen's license to audit The SEC revoked Andersen's license to audit public limited companies and ordered the firm public limited companies and ordered the firm to pay a fine of $1,000 for obstructing state to pay a fine of $1,000 for obstructing state investigation (this was the highest fine that a investigation (this was the highest fine that a state board could charge). state board could charge).



•The whole firm punished and its thousands The whole firm punished and its thousands of employees for the misdeeds of a handful of employees for the misdeeds of a handful of corrupt partners.of corrupt partners.

•Andersen's fall can be seen as a perfect Andersen's fall can be seen as a perfect example of how even great institutions example of how even great institutions founded on integrity, value, stewardship founded on integrity, value, stewardship and personal growth, could collapse in the and personal growth, could collapse in the absence of internal controls of absence of internal controls of management, a good work culture, and management, a good work culture, and sound values.sound values.


Satyam Satyam CaseCase

•Promoter and Chairman of the Company issued Promoter and Chairman of the Company issued misleading financial informationmisleading financial information

•Indulged in falsification of accounts, overstatement Indulged in falsification of accounts, overstatement of profits and debt owed to the Company and of profits and debt owed to the Company and understatement of liabilities understatement of liabilities

• Charged with offences of criminal conspiracy, Charged with offences of criminal conspiracy, cheating, impersonation, forgery etccheating, impersonation, forgery etc



•Price Waterhouse Coopers independent auditors Price Waterhouse Coopers independent auditors of the Company verified the accounts and of the Company verified the accounts and approved it approved it

•The role of Price Waterhouse Coopers- the The role of Price Waterhouse Coopers- the statutory auditors in “India’s Enron” comes under statutory auditors in “India’s Enron” comes under the spotlight amid allegations that large Indian the spotlight amid allegations that large Indian companies regularly use misleading accounting companies regularly use misleading accounting techniques and bully analysts, accountants and techniques and bully analysts, accountants and auditors into staying quiet.auditors into staying quiet.

•Proceedings started against Auditors alsoProceedings started against Auditors also



• The Company as a whole and the all the The Company as a whole and the all the employees of the Company had to suffer as a employees of the Company had to suffer as a result of the fraud by the Promoters and the result of the fraud by the Promoters and the ChairmanChairman

•Third Party Fault - Company liable - Price Third Party Fault - Company liable - Price Waterhouse Coopers failed to discharge its Waterhouse Coopers failed to discharge its duties.duties.

Compliance default riskCompliance default riskAssociationAssociation Compliance with laws e.g.Compliance with laws e.g.

(i)(i) Companies Act Companies Act

(ii)(ii) Income tax Act, Income tax Act,

(iii)(iii) Labour legislation Labour legislation

(iv)(iv) Banking Regulation Act by Banking Regulation Act by banking companies banking companies

(v)(v) Electricity Act by electricity Electricity Act by electricity companies etccompanies etc

(vi)(vi) Contract Act, 1872Contract Act, 1872

Compliance default riskCompliance default risk

ConsequencesConsequences •Entails Penal ProvisionsEntails Penal Provisions• Exposure to legal actions by Exposure to legal actions by regulatory authoritiesregulatory authorities

Minimized byMinimized by Legal Compliance AuditLegal Compliance Audit

Tax compliance riskTax compliance risk

AssociationAssociation •Non-payment of direct or Non-payment of direct or indirect taxes indirect taxes •Short payment thereofShort payment thereof•TDS deductionsTDS deductions

ConsequencesConsequences •Results in severe penal actionsResults in severe penal actions•Attachment of propertyAttachment of property•Fine / PenaltyFine / Penalty

Environmental riskEnvironmental risk

AssociationAssociation Discharge of polluting materialsDischarge of polluting materials

ConsequencesConsequences •Environmental offenceEnvironmental offence•Penal provisions enforcedPenal provisions enforced

ExampleExample Cola major fined for painting Cola major fined for painting advertisements in the hilly advertisements in the hilly regions of Himalayasregions of Himalayas

Environmental Environmental risk…Contdrisk…Contd

ExampleExample •Taj Trapezium Case Taj Trapezium Case

Courts held – since emissions Courts held – since emissions generated by the coke consuming generated by the coke consuming industries are damaging the Taj Mahal -industries are damaging the Taj Mahal -such industries have to use natural gas such industries have to use natural gas or relocateor relocate

Environmental risk…ContdEnvironmental risk…ContdExampleExample •Bhopal Gas Leak case Bhopal Gas Leak case

Forty tonnes of toxic gases escaped into Forty tonnes of toxic gases escaped into the air from the Union Carbides chemical the air from the Union Carbides chemical plant and took lives of 3500 peopleplant and took lives of 3500 people

Supreme Court directed the company to Supreme Court directed the company to pay US $ 470 million as compensationpay US $ 470 million as compensation

Minimized Minimized byby

•Business entity is required to restrict Business entity is required to restrict carbon and harmful gas emissions.carbon and harmful gas emissions.

IPR protection riskIPR protection risk

IPRIPR

Legal Legal ProtectionProtection

patent, copyright, trademark and patent, copyright, trademark and designs registration. designs registration.

Non Non Registrable Registrable IPR’sIPR’s

know-how and trade secretsknow-how and trade secrets

Minimized by Minimized by •Inserting confidentiality and non-Inserting confidentiality and non-disclosure clauses in the contract disclosure clauses in the contract •Representation on ownership of IPRRepresentation on ownership of IPR

Management of RiskManagement of Risk

Definition Definition •Estimation of probability of riskEstimation of probability of risk

•Implementation of risk treatments Implementation of risk treatments

Risk Risk TreatmentTreatment

•Risk avoidanceRisk avoidance•Risk reductionRisk reduction•Risk transferRisk transfer•Risk retentionRisk retention

Risk TreatmentRisk TreatmentRisk Risk avoidanceavoidance

•Activities that may invite risk are Activities that may invite risk are not performed or minimizednot performed or minimized•Example - Not buying a disputed Example - Not buying a disputed propertyproperty

Risk Risk reductionreduction

• Reduction of the severity of the Reduction of the severity of the loss loss •Example – Due Diligence, Example – Due Diligence, Background CheckBackground Check

Risk Treatment…..ContdRisk Treatment…..Contd

Risk Risk retentionretention

•Acceptance of loss. Acceptance of loss. •Risks that are incapable of being avoided Risks that are incapable of being avoided or reduced are retained by default.or reduced are retained by default.•Example – Events of Force Majeure Example – Events of Force Majeure

Risk Risk transfertransfer

•The loss is transferred to a third partyThe loss is transferred to a third party•Example - InsuranceExample - Insurance•Non assuming of third party claims in Non assuming of third party claims in ContractsContracts

Mitigation of RiskMitigation of Risk

DefinitionDefinition •Reduction of the loss or injury arising out Reduction of the loss or injury arising out of legal risk of legal risk

WaysWays • Limiting the liability of parties to the Limiting the liability of parties to the contractcontract•Quantifying DamagesQuantifying Damages•InsuranceInsurance•Specific representations and warranty Specific representations and warranty clausesclauses•Due DiligenceDue Diligence•IndemnityIndemnity

Contract and Risk Contract and Risk ManagementManagement

Impact of Impact of ContractContract

•Role in management Role in management •Operations Operations •Business activities of enterprisesBusiness activities of enterprises•Decides the legitimate rights and Decides the legitimate rights and interests of enterprises interests of enterprises

Ways Ways •Contract ReviewContract Review•Contract DraftingContract Drafting

Drafting of ContractDrafting of Contract

Developing key contractual elementsDeveloping key contractual elements

NegotiateNegotiate •key elements of the contractkey elements of the contract

ExamineExamine •concepts of considerationconcepts of consideration

MaintainMaintain •clear communicationclear communication

AnalyseAnalyse •conditions and warranty clausesconditions and warranty clauses


Ensuring the foundations of the contract are Ensuring the foundations of the contract are secure at the bargaining tablesecure at the bargaining table

UnderstandUnderstand •requirements to ensure the contract requirements to ensure the contract protects their business interestsprotects their business interests•technical and legal expectationstechnical and legal expectations•special inclusions / exclusions special inclusions / exclusions requiredrequired

UtiliseUtilise •techniques to obtain the desired techniques to obtain the desired outcome when commercial leverage outcome when commercial leverage is absentis absent


Ensuring the foundations of the contract are Ensuring the foundations of the contract are secure at the bargaining tablesecure at the bargaining table

AnalyseAnalyse •risk of offers and acceptancerisk of offers and acceptance

•will your client be inadvertently will your client be inadvertently contractedcontracted


Effective dispute Effective dispute resolution clausesresolution clauses

ExamineExamine Dispute resolution optionsDispute resolution options

DetermineDetermine •Courtroom Litigation v ArbitrationCourtroom Litigation v Arbitration•Forum Forum •Applicable LawApplicable Law

AimAim Ensure enforceability of awardEnsure enforceability of award


LITIGATIONLITIGATION ARBITRATIONARBITRATION

FormalFormal

No control over JudgesNo control over Judges

InformalInformal

Arbitrators appointed by Arbitrators appointed by partiesparties

Public DomainPublic Domain ConfidentialityConfidentiality

No experience in the No experience in the subject matter of the subject matter of the disputedispute

Practical experience of Practical experience of technicalities in questiontechnicalities in question

Drafting of Drafting of Contract….ContdContract….Contd

Judges powers limited Judges powers limited

Determine and enforce Determine and enforce the contractual rights of the contractual rights of partiesparties

Arbitrators can modify the Arbitrators can modify the contractual rights of the contractual rights of the partiesparties

May substitute their May substitute their discretion as rights discretion as rights expressly given by expressly given by agreementagreement

Very Lengthy ProcessVery Lengthy Process Less time ConsumingLess time Consuming

Less costly than Less costly than arbitrationarbitration

Costly affairCostly affair


Drafting effective Indemnity ClausesDrafting effective Indemnity Clauses

IndemnityIndemnity safeguard against established risksafeguard against established risk

IdentifyIdentify critical issuescritical issues

ConsiderConsider consequential loss and exclusion consequential loss and exclusion clausesclauses


Drafting effective Indemnity ClausesDrafting effective Indemnity Clauses

LearnLearn utilise clauses to protect against utilise clauses to protect against ambiguityambiguity

UnderstandUnderstand probability of loss may arise as a probability of loss may arise as a consequence of breach of contractconsequence of breach of contract

DefineDefine consequential lossconsequential loss

Contract EnforceabilityContract EnforceabilityExamineExamine •legal enforceability - clauselegal enforceability - clause

•example - Contract of wagering example - Contract of wagering •void in India but enforceable in void in India but enforceable in AustraliaAustralia

RemoveRemove •ambiguityambiguity

ReviewReview •impact of recent case law on impact of recent case law on contractual indemnitiescontractual indemnities

UnderstandUnderstand •scope of recoverable loss or scope of recoverable loss or damagedamage

Contract ReviewContract Review

DefinitionDefinition •A rational analysis of ContractA rational analysis of Contract•Includes feasibility of contract and Includes feasibility of contract and forecast of contract risksforecast of contract risks

ClassificationClassification •Prior ReviewPrior Review•A review of the Contract from legal A review of the Contract from legal perspectiveperspective•Post ReviewPost Review•Review of the Contract taking into Review of the Contract taking into account the Clients requirementaccount the Clients requirement

Contract Review…..ContdContract Review…..ContdClassificationClassification •Operational ReviewOperational Review

•Pertaining to the financial viability and Pertaining to the financial viability and internal regulationsinternal regulations•Legal Review - Legal Review - Two typesTwo types

Formal Formal ReviewReview

•Subject MatterSubject Matter•General InformationGeneral Information•QualificationQualification•Credibility and contractual Credibility and contractual capacitycapacity

Substantive Substantive ReviewReview

•Rights and Obligations of Rights and Obligations of parties to the Contractparties to the Contract

Contract Review…..ContdContract Review…..ContdSubstantive Substantive ReviewReview

Review every clause of the Review every clause of the Agreement/ContractAgreement/Contract

ExampleExample Joint Venture Agreement Joint Venture Agreement

Incorporation of Company in India Incorporation of Company in India

Capital Capital StructureStructure

Private Limited- Rs 1,00,000Private Limited- Rs 1,00,000

Public Limited – Rs 5,00,000Public Limited – Rs 5,00,000

ShareholderShareholder Private Limited- 2Private Limited- 2

Public Limited – 7Public Limited – 7

DirectorsDirectors Preferably odd number of directorsPreferably odd number of directors

Decisions taken by majorityDecisions taken by majority

Contract Review…..ContdContract Review…..Contd

Chief Executive Chief Executive OfficerOfficer

AppointmentAppointment

RemunerationRemuneration

Financial PolicyFinancial Policy Domestic/ForeignDomestic/Foreign

FDI – Direct/IndirectFDI – Direct/Indirect

RBI ApprovalsRBI Approvals

ApprovalApproval Governments and other Governments and other statutory authority/iesstatutory authority/ies

Example: Labour LawsExample: Labour Laws

Procedural Compliance relating Procedural Compliance relating to Securities laws i.e. Stock to Securities laws i.e. Stock Exchange/ SEBI requirementsExchange/ SEBI requirements

Contract Review…..ContdContract Review…..Contd

Execution of Execution of AgreementsAgreements

Proper stamp duty been paid on the Proper stamp duty been paid on the agreementsagreements

Immovable property valuing Rs 100 Immovable property valuing Rs 100 or moreor more

Registration, admitted execution Registration, admitted execution and registered by the registrar.and registered by the registrar.

Preventive MeasuresPreventive Measures• Legal Compliance Audit (LCA)Legal Compliance Audit (LCA)

• periodical audit to verify, check and confirm periodical audit to verify, check and confirm compliance by statutory laws including rules, compliance by statutory laws including rules, guidelines, notifications and any amendments guidelines, notifications and any amendments related to company laws, banking laws, property related to company laws, banking laws, property laws, securities laws, commercial laws, laws, securities laws, commercial laws, constitutional laws, consumer laws, taxation laws constitutional laws, consumer laws, taxation laws and other relevant laws depending upon the and other relevant laws depending upon the nature of business .nature of business .

• Example Example • Hotel Business- Food and adulteration actHotel Business- Food and adulteration act

Preventive MeasuresPreventive Measures

• LCA assumes greater importance. LCA helps LCA assumes greater importance. LCA helps the managementthe management

• to ensure that legal compliances are to ensure that legal compliances are adequately madeadequately made

• to take corrective action in case of non-to take corrective action in case of non-compliancecompliance

Risk RegistersRisk Registers

RecordsRecords •identified risks, their severity, and the identified risks, their severity, and the actions/steps to be takenactions/steps to be taken

Simple Simple documentdocument

•spreadsheet, or a database system spreadsheet, or a database system

ProvidesProvides •assessment on how likely it is that this assessment on how likely it is that this risk will occur. risk will occur. •assessment of the impact that the assessment of the impact that the occurrence of this risk would have on the occurrence of this risk would have on the projectproject

Risk Registers…ContdRisk Registers…ContdActionAction prevent, reduce or transfer the prevent, reduce or transfer the

risk. risk.

Includes - production of Includes - production of contingency plans. contingency plans.

ResponsibilityResponsibility Individual - for the ensuring this Individual - for the ensuring this risk is appropriately managed risk is appropriately managed and counter measures are and counter measures are undertakenundertaken

IndicatesIndicates current risk or if risk can no current risk or if risk can no longer arise and impact the longer arise and impact the project. project.

ANY QUERIES ????ANY QUERIES ????

THANK YOU !THANK YOU !

Universal Legal, Advocates5th Floor, Kimatrai Building,

77/79, Maharshi Karve Road,Mumbai – 400 002

Tel: +91 22 22034293-95Fax: +91 22 2209845

Email: [email protected]

risk

Documents

contd risk

mitigating legal risk

operational legal risk

product liability risk

kinds of legal risk

active risk identification

company example

chance of loss legal