Understanding legal risk: what every business needs to know

Risk is an integral part of business, and while most businesses have a good understanding of, and systems in place for their key operational risks, many remain unprepared for (or worse, unaware of) the financial pressures and loss of reputation that a serious legal risk can produce, writes Mellissa Larkin, founder and managing director of Peripheral Blue Legal.

So how do you identify, prepare for and manage the different types of legal risks facing your business? Let’s get started.

What is legal risk?

Legal risk is the likelihood of financial or reputational loss resulting from a lack of knowledge (or misunderstanding) of how the law applies to your business, or operating with a reckless indifference to the law and how it applies.

How do you identify your potential legal risks?

Legal risk management starts with identifying possible threats, which could cause loss or disruption to your business, enabling you to implement processes to minimise or negate them.

First, compile a list of potential legal risks. Once identified, analyse each risk to determine how likely it is to impact your business, and how severe the impact would be.

Impact is typically measured and prioritised by financial impact, with priority given to the most potentially expensive risks. However, other factors such as reputational damage and cultural impact are also important.

Below are some of the types of legal risk a company should consider when creating a legal risk management framework, and some strategies for dealing with them if they arise.

1. Contract risk – do your contracts protect your interests?

Traditionally, contracting has been seen as primarily a cost-centre for the business. But contracts play a crucial strategic role in your business and should be given the time and resources to match.

Examples include:

• Failure to properly review a contract, resulting in mistakes that could affect enforcement of its terms (i.e. referring to incorrect governing law)
• Inadvertent signing up to unlimited indemnities or other terms creating unexpected liabilities
• Products or services not accurately described, leading to a dispute or the inability to make a claim
• Not keeping track of deadlines, which could result in a breach or failure to close an important deal
• Failure to identify changes to laws and regulations (and keep contracts updated), which may result in a contract being rendered void

An effective contract management system will help to ensure that contracts are properly executed, deadlines are met, and contingency plans are in place to mitigate risk.

2. Legislative compliance risks – are you complying with all relevant laws?

The regulatory landscape is constantly shifting. It is important that your company has systems and processes in place to identify when laws have changed that affect your business. You should be in a position to proactively implement compliance measures so that you can stay on the front foot of your requirements.

In addition, you may need to ensure that staff are trained in new requirements and that policies can be effectively implemented before new laws commence.

Regulatory compliance gone wrong can be a hefty cost to the business, not just financially, but also in hours spent by staff in response to any regulatory action or investigation. Not to mention potential reputational damage!

3. Privacy compliance and data breach risk

Businesses face legal risks that are continually emerging and evolving. One area where there is overlap of two legal risk areas (contract and legislative compliance) is the risk of a data breach.

Holding large quantities of data makes companies a tempting target for hackers. A data breach poses a serious risk of litigation and possible hefty fines for non-compliance with the Notifiable Data Breaches scheme in Australia.

Cyber security is only one part of an organisation’s defence against the impact of a data breach. Strong privacy governance is critical in ensuring that the organisation’s information handling practices do not expose them to greater risk of a breach, and that they can respond quickly to any breach that occurs.

Often, where a data breach occurs, one of the most critical factors is the perception of how well (or not) the fall-out is handled. So having a comprehensive Data Breach Plan is imperative for any company that handles personal information.

Establishing effective internal privacy management and governance – such as compliant internal procedures and clear privacy notices – is essential and separate from any IT data storage and protections you have in place.

Further, if your business outsources services where third parties handle personal information on your behalf, you need to be sure that they are handling it in a responsible manner. You also need to ensure that they are complying with any relevant privacy laws by imposing obligations in your contracts with them.

Manage risk properly and reap the rewards

With the right planning, implementation, monitoring and revision, sound risk management can produce the following benefits for your business, no matter what size it is:

• Lower insurance premiums
• Reduced likelihood of becoming a target of legal action
• Reduced losses of cash or stock
• Reduced management time dealing with incidents or business down time
• Acceleration of revenue
• Reduced chance of reputational damage

You work hard to ensure that your company is profitable and maintains an excellent reputation. Don’t risk that by losing sight of all of the legal risks inherent in running a business.

On that note, a trusted legal adviser will be one of your best assets.

This post was originally published in 2019 and has been updated for 2022.

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