Businesses that fail to mitigate their legal risk pay a heavy price, and the repercussions of not addressing legal risks can be substantial. According to a recent survey by YouGov with CEBR, the annual financial impact on UK SMEs that have not adequately addressed their legal risks is as much as £13.6 billion. When business leaders think about ‘legal risks,’ they immediately jump to thoughts of litigation and the spiraling costs of legal proceedings, but there are many other legal risks a business needs to consider. It is critical to understand the broader spectrum of potential consequences and implement a solid legal risk framework to shield your business from various financial and operational setbacks.
Understand Your Business
A fundamental first step is to fully grasp your business model, operations, and the industry you operate in. Before even thinking about specific legal risks, it’s essential to understand the unique aspects of your business that give it value. Start with strategic conversations with the senior leadership team to ensure everyone is on the same page regarding the business’s direction and potential threats. Review key strategic documents and conduct detailed discussions with each leader about the functional areas they manage and the specific legal risks they may face.
When initially assessing these risks, avoid viewing them purely through a legal lens. Instead, consider what could potentially threaten the core value propositions of your business. Identify what makes your business a valuable entity—be it intellectual property, its market positioning, customer relationships, or another critical aspect. This comprehensive understanding will help you determine what is crucial to protect within the organization and establish your risk tolerance accordingly. Setting your risk appetite is a vital part of this process, ensuring that your business is prepared to manage and mitigate different levels of risk effectively.
Identify the Risks
Once you thoroughly understand your business, the next step is to categorize the various types of risks you might encounter. Risks can generally be divided into areas such as legislative/regulatory risk, non-contractual risk, contractual risk, dispute/litigation risk, and non-contractual rights risk. By organizing potential threats into these categories, you create a structured approach to risk management that allows for targeted interventions.
Setting your risk appetite and Key Risk Indicators (KRIs) for each identified area is critical. These indicators will help you monitor and evaluate how well you are managing each type of risk. Additionally, appoint a ‘risk owner’ in each functional area of your business. These individuals will be responsible for addressing risks according to the agreed-upon risk tolerance, meeting all regulatory and compliance requirements, and ensuring that all policies are up to date and all contracts are practicable. By assigning ownership, you create accountability and ensure that risks are not overlooked.
Collating and assessing this information against your KRIs allows you to use tools like grading or traffic light systems to log risks effectively. This systematic approach ensures that you can quickly identify areas of concern and take appropriate action before issues escalate. Continuously updating and reviewing these logs keep the risk management process dynamic and responsive to emerging threats.
Set Up Processes
Ensuring senior-level sign-off for any business actions outside agreed tolerances is crucial, and documenting those decisions provides a clear audit trail. It’s essential to maintain a snapshot showing where out-of-tolerance risks exist across the organization. This visibility allows management to address any high-risk areas promptly and ensures that there are no blind spots in your risk management strategy.
Establishing these processes involves more than just creating a paper trail; it requires embedding a risk-aware culture within your organization. Encourage open communication about risks and ensure that staff at all levels understand the importance of following established procedures. A risk-aware culture not only helps in identifying and managing risks more effectively but also fosters a sense of accountability and responsibility among employees.
Processes should also include regular training and updates to keep everyone informed about new regulations, industry standards, and best practices in risk management. Keeping your team educated and up to date ensures that they are well-equipped to handle and mitigate risks as they arise.
Monitor
Implementing internal checks, or the ‘second line of defense,’ is a key part of monitoring your risk management framework. Assign someone outside each business function to monitor whether risks are being properly recorded, signed off, and addressed. This independent verification ensures that no one is “marking their own homework” and that all risks are being managed impartially.
External independent assurance, or the ‘third line of defense,’ involves scheduling periodic audits to inspect and provide feedback on your legal risks and compliance state. These audits, which can occur annually or every few years, offer an objective review of your risk management processes and highlight areas for improvement. Independent audits are particularly valuable as they bring a fresh perspective and can identify gaps or weaknesses that internal teams may have missed.
Regular monitoring and audits create a feedback loop that helps you continuously refine and improve your risk management framework. By staying vigilant and proactive, you can address issues before they escalate into major problems, thereby protecting your business from potentially severe legal and financial consequences.
Report to the Board
Developing a high-level report on legal risk that incorporates snapshots from each functional area is essential for transparent and effective risk management. This report should be prepared regularly and presented to the board to ensure they can verify that established risk levels are being adhered to and that robust processes are in place. Providing the board with a clear and comprehensive overview of the business’s risk landscape enables informed decision-making and strategic planning.
The report should highlight key risks, their potential impacts, and the measures being taken to mitigate them. It should also show how well the business adheres to its risk appetite and any out-of-tolerance risks that require immediate attention. By keeping the board informed, you ensure that risk management remains a priority at the highest levels of the organization and that there is ongoing support and resources for mitigating risks.
Effective reporting also involves open and transparent communication with the board about any challenges or issues encountered in managing risks. This candid approach fosters trust and ensures that the board is fully aware of the risk environment, enabling them to provide the necessary guidance and support to address any emerging threats.
Review Regularly
Businesses that ignore their legal risks often face severe consequences. A recent survey by YouGov and CEBR found that UK small and medium-sized enterprises (SMEs) that have not adequately managed their legal risks incur annual financial losses totaling up to £13.6 billion. When business leaders think about ‘legal risks,’ they usually envision lawsuits and the skyrocketing costs of legal battles. However, there are many other legal threats a business must consider. Legal risks encompass a wide array of issues, from regulatory compliance and contractual obligations to intellectual property disputes and employee relations. Ignoring these risks can lead to significant financial setbacks, reputational damage, and operational disruptions.
To protect your company, it is crucial to understand the broader spectrum of legal risks and adopt a comprehensive legal risk management strategy. Such a framework involves regular legal audits, staying updated on relevant laws and regulations, training employees on compliance issues, and having a response plan in place for potential legal challenges. Implementing these measures not only shields your business from the immediate costs of legal issues but also promotes long-term stability and success. By being proactive about legal risk management, businesses can navigate potential pitfalls and operate more securely and efficiently.
