Risk

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mitigation risks through legal contracts

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Risk

  1. 1. RISK IN LEGAL CONTRACTS APURVA AGARWAL PARTNER UNIVERSAL LEGAL August 14, 2009
  2. 2. <ul><li>PREDICTING AND MITIGATING LEGAL RISK THROUGH ACTIVE RISK IDENTIFICATION WHILE STRESSING ON EFFECTIVE RISK MANAGEMENT EFFORTS </li></ul>
  3. 3. <ul><li>Nothing is pervasive like law as a person, whether natural or artificial, is governed by law right from birth to death. </li></ul>
  4. 4. RISK <ul><li>Financial </li></ul><ul><li>Political </li></ul><ul><li>Fidelity </li></ul><ul><li>Legal </li></ul>Types of Risk - Business hazard: a source of danger; a possibility of incurring loss or misfortune Definition
  5. 5. Legal Risk…..Definition a chance of encountering a situation in which one has to suffer loss or injury Common Usage peril, hazard or chance of loss Legal Parlance as a chance or probability of danger, loss, injury or other adverse consequence Oxford Dictionary
  6. 6. RISK EXPOSURE <ul><li>Business organizations </li></ul>Well tailored risk treatment plans Minimized Legal Risks Contractual Risks Exposure Applicable Laws Business Relations Governed
  7. 7. Kinds of Legal Risk <ul><li>failure to protect its intellectual property assets </li></ul><ul><li>shareholders decision contrary to the decision of the management of the company </li></ul>Example <ul><li>Associated with maintenance of the companies assets and property </li></ul><ul><li>Internal affairs of the Company </li></ul>Organizational Legal Risk
  8. 8. Kinds of Legal Risk the company does not take warranties from its counterparty, but relies instead on its due diligence procedures Example <ul><li>methods adopted and steps taken to protect the company’s assets </li></ul><ul><li>protection against </li></ul><ul><li>claims by others </li></ul><ul><li>liability to pay compensation </li></ul>Legal Methodology Risk
  9. 9. Kinds of Legal Risk <ul><li>The possibility that contractual rights will be void or unenforceable due to: </li></ul><ul><li>illegality; </li></ul><ul><li>a technical defect (e.g. lack of restriction or registration); </li></ul><ul><li>lack of capacity (of either party ); </li></ul>Example Obligations or liabilities that were not foreseen, or are greater than were foreseen Operational Legal Risk
  10. 10. LEGAL RISK….Contd Risk suffered by Companies Two Types of Loss/ Injury <ul><li>Imprisonment </li></ul><ul><li>Borne by Directors </li></ul>Corporeal Loss <ul><li>Damages </li></ul><ul><li>Borne by Company </li></ul>Pecuniary Loss
  11. 11. Legal Risk….Contd Example Reasons <ul><li>Contract for Prostitution </li></ul><ul><li>Unenforceable in India / Middle East Countries </li></ul><ul><li>Enforceable in Australia </li></ul>Contractual provisions unenforceable
  12. 12. Legal Risk….Contd <ul><li>A agrees to sell 10 mtrs of </li></ul><ul><li>cloth </li></ul><ul><li>No description of cloth </li></ul>Obligations of the Parties ambiguous Liabilities of parties not documented Contractual Provisions inadequately drafted
  13. 13. LEGAL RISK….Contd <ul><li>Civil i.e. compliance defaults, breach of contract etc or </li></ul><ul><li>Criminal i.e. cheating, breach of trust, fraud etc </li></ul>Offence <ul><li>Company </li></ul><ul><li>Officers In Charge – conduct of the affairs of the company </li></ul>Responsibility
  14. 14. Kinds of Legal Risk <ul><li>Product liability </li></ul><ul><li>Employee liability </li></ul><ul><li>Compliance default </li></ul><ul><li>Tax compliance </li></ul><ul><li>Environmental </li></ul><ul><li>IPR </li></ul>
  15. 15. Product Liability Risk <ul><li>Inserting proper Liability limitation Clauses </li></ul><ul><li>Limiting liability of the manufacturer and fixes the liability on the sub-contractors. </li></ul>Minimized by <ul><li>Manufacturing Companies - Exposed </li></ul><ul><li>Minimized by outsourcing the work </li></ul>Example <ul><li>Final product </li></ul><ul><li>Arising from the performance of the spare parts or components </li></ul>Association
  16. 16. Management Liability Risk <ul><li>Execution of proper Employment contract </li></ul><ul><li>Statutory compliances like labour laws </li></ul><ul><li>Limiting liability of the Company for the acts of its employees/ directors/ manager. </li></ul>Minimized By <ul><li>Deduction and payments of employee welfare statutory dues like provident fund, ESI contribution, bonus, gratuity, wages etc </li></ul><ul><li>Company held responsible for the act of its employees/directors/managers </li></ul>Association
  17. 17. Management Liability Risk….Contd <ul><li>Case Law </li></ul><ul><li>Enron a US Company accounts were “WINDOW DRESSED” show a healthy financial position. Filed for bankruptcy in December 2001. </li></ul><ul><li>Andersen - internal and external auditor of Enron since the mid-1990s </li></ul><ul><li>Security and Exchange Commission (SEC) investigating various charges against Enron </li></ul>Arthur Anderson Case
  18. 18. Management Liability Risk….Contd <ul><li>The DOJ, found Andersen guilty of obstructing SEC's proceedings. </li></ul><ul><li>The SEC revoked Andersen's license to audit public limited companies and ordered the firm to pay a fine of $1,000 for obstructing state investigation (this was the highest fine that a state board could charge). </li></ul>Arthur Anderson Case
  19. 19. Management Liability Risk….Contd <ul><li>The whole firm punished and its thousands of employees for the misdeeds of a handful of corrupt partners. </li></ul><ul><li>Andersen's fall can be seen as a perfect example of how even great institutions founded on integrity, value, stewardship and personal growth, could collapse in the absence of internal controls of management, a good work culture, and sound values. </li></ul>Arthur Anderson Case
  20. 20. Management Liability Risk….Contd <ul><li>Promoter and Chairman of the Company issued misleading financial information </li></ul><ul><li>Indulged in falsification of accounts, overstatement of profits and debt owed to the Company and understatement of liabilities </li></ul><ul><li>Charged with offences of criminal conspiracy, cheating, impersonation, forgery etc </li></ul>Satyam Case
  21. 21. Management Liability Risk….Contd <ul><li>Price Waterhouse Coopers independent auditors of the Company verified the accounts and approved it </li></ul><ul><li>The role of Price Waterhouse Coopers- the statutory auditors in “India’s Enron” comes under the spotlight amid allegations that large Indian companies regularly use misleading accounting techniques and bully analysts, accountants and auditors into staying quiet. </li></ul><ul><li>Proceedings started against Auditors also </li></ul>Satyam Case
  22. 22. Management Liability Risk….Contd <ul><li>The Company as a whole and the all the employees of the Company had to suffer as a result of the fraud by the Promoters and the Chairman </li></ul><ul><li>Third Party Fault - Company liable - Price Waterhouse Coopers failed to discharge its duties. </li></ul>Satyam Case
  23. 23. Compliance default risk <ul><li>Compliance with laws e.g. </li></ul><ul><li>Companies Act </li></ul><ul><li>Income tax Act, </li></ul><ul><li>Labour legislation </li></ul><ul><li>Banking Regulation Act by banking companies </li></ul><ul><li>Electricity Act by electricity companies etc </li></ul><ul><li>Contract Act, 1872 </li></ul>Association
  24. 24. Compliance default risk Legal Compliance Audit Minimized by <ul><li>Entails Penal Provisions </li></ul><ul><li>Exposure to legal actions by regulatory authorities </li></ul>Consequences
  25. 25. Tax compliance risk <ul><li>Results in severe penal actions </li></ul><ul><li>Attachment of property </li></ul><ul><li>Fine / Penalty </li></ul>Consequences <ul><li>Non-payment of direct or indirect taxes </li></ul><ul><li>Short payment thereof </li></ul><ul><li>TDS deductions </li></ul>Association
  26. 26. Environmental risk Cola major fined for painting advertisements in the hilly regions of Himalayas Example <ul><li>Environmental offence </li></ul><ul><li>Penal provisions enforced </li></ul>Consequences Discharge of polluting materials Association
  27. 27. Environmental risk…Contd <ul><li>Taj Trapezium Case </li></ul><ul><li>Courts held – since emissions generated by the coke consuming industries are damaging the Taj Mahal -such industries have to use natural gas or relocate </li></ul>Example
  28. 28. Environmental risk…Contd <ul><li>Business entity is required to restrict carbon and harmful gas emissions. </li></ul>Minimized by <ul><li>Bhopal Gas Leak case </li></ul><ul><li>Forty tonnes of toxic gases escaped into the air from the Union Carbides chemical plant and took lives of 3500 people </li></ul><ul><li>Supreme Court directed the company to pay US $ 470 million as compensation </li></ul>Example
  29. 29. IPR protection risk <ul><li>Inserting confidentiality and non-disclosure clauses in the contract </li></ul><ul><li>Representation on ownership of IPR </li></ul>Minimized by know-how and trade secrets Non Registrable IPR’s patent, copyright, trademark and designs registration. IPR Legal Protection
  30. 30. Management of Risk <ul><li>Risk avoidance </li></ul><ul><li>Risk reduction </li></ul><ul><li>Risk transfer </li></ul><ul><li>Risk retention </li></ul>Risk Treatment <ul><li>Estimation of probability of risk </li></ul><ul><li>Implementation of risk treatments </li></ul>Definition
  31. 31. Risk Treatment <ul><li>Reduction of the severity of the loss </li></ul><ul><li>Example – Due Diligence, Background Check </li></ul>Risk reduction <ul><li>Activities that may invite risk are not performed or minimized </li></ul><ul><li>Example - Not buying a disputed property </li></ul>Risk avoidance
  32. 32. Risk Treatment…..Contd <ul><li>The loss is transferred to a third party </li></ul><ul><li>Example - Insurance </li></ul><ul><li>Non assuming of third party claims in Contracts </li></ul>Risk transfer <ul><li>Acceptance of loss. </li></ul><ul><li>Risks that are incapable of being avoided or reduced are retained by default. </li></ul><ul><li>Example – Events of Force Majeure </li></ul>Risk retention
  33. 33. Mitigation of Risk <ul><li>Limiting the liability of parties to the contract </li></ul><ul><li>Quantifying Damages </li></ul><ul><li>Insurance </li></ul><ul><li>Specific representations and warranty clauses </li></ul><ul><li>Due Diligence </li></ul><ul><li>Indemnity </li></ul>Ways <ul><li>Reduction of the loss or injury arising out of legal risk </li></ul>Definition
  34. 34. Contract and Risk Management <ul><li>Contract Review </li></ul><ul><li>Contract Drafting </li></ul>Ways <ul><li>Role in management </li></ul><ul><li>Operations </li></ul><ul><li>Business activities of enterprises </li></ul><ul><li>Decides the legitimate rights and interests of enterprises </li></ul>Impact of Contract
  35. 35. Drafting of Contract <ul><li>Developing key contractual elements </li></ul><ul><li>conditions and warranty clauses </li></ul>Analyse <ul><li>clear communication </li></ul>Maintain <ul><li>concepts of consideration </li></ul>Examine <ul><li>key elements of the contract </li></ul>Negotiate
  36. 36. Drafting of Contract <ul><li>Ensuring the foundations of the contract are secure at the bargaining table </li></ul><ul><li>techniques to obtain the desired outcome when commercial leverage is absent </li></ul>Utilise <ul><li>requirements to ensure the contract protects their business interests </li></ul><ul><li>technical and legal expectations </li></ul><ul><li>special inclusions / exclusions required </li></ul>Understand
  37. 37. Drafting of Contract <ul><li>Ensuring the foundations of the contract are secure at the bargaining table </li></ul><ul><li>risk of offers and acceptance </li></ul><ul><li>will your client be inadvertently contracted </li></ul>Analyse
  38. 38. Drafting of Contract <ul><li>Effective dispute resolution clauses </li></ul>Ensure enforceability of award Aim <ul><li>Courtroom Litigation v Arbitration </li></ul><ul><li>Forum </li></ul><ul><li>Applicable Law </li></ul>Determine Dispute resolution options Examine
  39. 39. Drafting of Contract Confidentiality Public Domain Practical experience of technicalities in question No experience in the subject matter of the dispute Informal Arbitrators appointed by parties Formal No control over Judges ARBITRATION LITIGATION
  40. 40. Drafting of Contract….Contd Arbitrators can modify the contractual rights of the parties May substitute their discretion as rights expressly given by agreement Judges powers limited Determine and enforce the contractual rights of parties Costly affair Less costly than arbitration Less time Consuming Very Lengthy Process
  41. 41. Drafting of Contract….Contd <ul><li>Drafting effective Indemnity Clauses </li></ul>safeguard against established risk Indemnity consequential loss and exclusion clauses Consider critical issues Identify
  42. 42. Drafting of Contract….Contd <ul><li>Drafting effective Indemnity Clauses </li></ul>utilise clauses to protect against ambiguity Learn probability of loss may arise as a consequence of breach of contract Understand consequential loss Define
  43. 43. Contract Enforceability <ul><li>impact of recent case law on contractual indemnities </li></ul>Review <ul><li>scope of recoverable loss or damage </li></ul>Understand <ul><li>ambiguity </li></ul>Remove <ul><li>legal enforceability - clause </li></ul><ul><li>example - Contract of wagering </li></ul><ul><li>void in India but enforceable in Australia </li></ul>Examine
  44. 44. Contract Review <ul><li>Prior Review </li></ul><ul><li>A review of the Contract from legal perspective </li></ul><ul><li>Post Review </li></ul><ul><li>Review of the Contract taking into account the Clients requirement </li></ul>Classification <ul><li>A rational analysis of Contract </li></ul><ul><li>Includes feasibility of contract and forecast of contract risks </li></ul>Definition
  45. 45. Contract Review…..Contd <ul><li>Operational Review </li></ul><ul><li>Pertaining to the financial viability and internal regulations </li></ul><ul><li>Legal Review - Two types </li></ul>Classification <ul><li>Rights and Obligations of parties to the Contract </li></ul>Substantive Review <ul><li>Subject Matter </li></ul><ul><li>General Information </li></ul><ul><li>Qualification </li></ul><ul><li>Credibility and contractual capacity </li></ul>Formal Review
  46. 46. Contract Review…..Contd Private Limited- 2 Public Limited – 7 Shareholder Preferably odd number of directors Decisions taken by majority Directors Private Limited- Rs 1,00,000 Public Limited – Rs 5,00,000 Capital Structure Joint Venture Agreement Incorporation of Company in India Example Review every clause of the Agreement/Contract Substantive Review
  47. 47. Contract Review…..Contd Governments and other statutory authority/ies Example: Labour Laws Procedural Compliance relating to Securities laws i.e. Stock Exchange/ SEBI requirements Approval Domestic/Foreign FDI – Direct/Indirect RBI Approvals Financial Policy Appointment Remuneration Chief Executive Officer
  48. 48. Contract Review…..Contd Proper stamp duty been paid on the agreements Immovable property valuing Rs 100 or more Registration, admitted execution and registered by the registrar. Execution of Agreements
  49. 49. Preventive Measures <ul><li>Legal Compliance Audit (LCA) </li></ul><ul><li>periodical audit to verify, check and confirm compliance by statutory laws including rules, guidelines, notifications and any amendments related to company laws, banking laws, property laws, securities laws, commercial laws, constitutional laws, consumer laws, taxation laws and other relevant laws depending upon the nature of business . </li></ul><ul><li>Example </li></ul><ul><li>Hotel Business- Food and adulteration act </li></ul>
  50. 50. Preventive Measures <ul><li>LCA assumes greater importance. LCA helps the management </li></ul><ul><li>to ensure that legal compliances are adequately made </li></ul><ul><li>to take corrective action in case of non-compliance </li></ul>
  51. 51. Risk Registers <ul><li>assessment on how likely it is that this risk will occur. </li></ul><ul><li>assessment of the impact that the occurrence of this risk would have on the project </li></ul>Provides <ul><li>spreadsheet, or a database system </li></ul>Simple document <ul><li>identified risks, their severity, and the actions/steps to be taken </li></ul>Records
  52. 52. Risk Registers…Contd current risk or if risk can no longer arise and impact the project. Indicates Individual - for the ensuring this risk is appropriately managed and counter measures are undertaken Responsibility prevent, reduce or transfer the risk. Includes - production of contingency plans. Action
  53. 53. <ul><li>ANY QUERIES ???? </li></ul>
  54. 54. <ul><li>THANK YOU ! </li></ul><ul><li>Universal Legal, Advocates </li></ul><ul><li>5th Floor, Kimatrai Building, </li></ul><ul><li>77/79, Maharshi Karve Road, </li></ul><ul><li>Mumbai – 400 002 </li></ul><ul><li>Tel: +91 22 22034293-95 </li></ul><ul><li>Fax: +91 22 2209845 </li></ul><ul><li>Email: [email_address] </li></ul>

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