Legal Briefing

The rise of risk management

The In-House Lawyer Logo

Litigation | 10 July 2018

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Large businesses today operate in a challenging and uncertain environment. The geopolitical landscape continues to shift in unpredictable ways with, for example, the political, regulatory and economic ramifications of the Brexit vote and the Trump presidency still largely to play out. Stock markets have started to experience jitters following the second-longest bull run in history, while growth in many economies and for many organisations stubbornly refuses to reach pre-financial crisis levels.

Berger,-Elliot-Action and reaction

Transformation is occurring across all industries at an accelerating pace, whether driven by technology, transparency or changing customer preferences. Companies operate in a state of almost continual flux: new operating models, turnovers in leadership and new product bets are all more frequent than before. To quote a Google executive, ‘change has never happened this fast before and will never be this slow again’.

This contributes to a complex – and often costly – risk environment for companies to manage. One reaction has been a doubling of the number of assurance functions across the last ten years – such as enterprise risk management, compliance, cyber security, and data privacy teams. Another has been a reduction in risk appetite – research shows more than three quarters of leadership teams have become more risk averse when investing in new projects.

New approaches to risk

This has led to the proliferation of new approaches taken by companies to mitigate risks. New risks, such as those surrounding data breaches and ransomware can now be partly managed, for example through cyber insurance.

Companies are also now looking at ever-present risks, and seeking new ways to mitigate them. For example, recent years have seen the adoption of financial hedging products or insurance in areas like business interruption. Companies also seek more external support to assist with previously internally performed tasks such as supplier due diligence.

Litigation is another longstanding corporate concern, and part of the trend among executives looking to new ways to hedge their risks. More and more large, well-resourced corporates utilise funding to shift some or all of the risk of an adverse outcome in litigation or arbitration.

The personal impact of disputes

The struggle to find sustained growth, ever-increasing business expenses and demands to deliver savings, mean that corporate budgets remain tight. The risks inherent to even the most solid of claims are well understood. While legal fees may be just a fraction of a large company’s total G&A expenses, it is common for those costs to be allocated to an individual business unit or country budget, where the fees can have a significant impact.

For those local business leaders and finance directors, the cash spent pursuing claims may not then be available for other core business-building activities. The impact becomes particularly personal for those who are measured on business performance or variance from a pre-agreed budget or target. Expenses for claims are unpredictable, last for several months or years, and come with no guarantee of a return – and sometimes the exact opposite in the case of an adverse costs award. As such, it’s not surprising that CFOs tell us that lawyers’ fees are often a big topic of conversation at management meetings.

Solutions to manage legal disputes

Litigation funding resolves these problems by offering corporate claimants the opportunity to shift the entirety of this litigation risk on to a third party. It provides comfort to business managers who need to make the internal case to pursue a claim in today’s risk-averse environment, and offers a host of financial and reporting benefits.

For example, when a company funds its own litigation, lawyers’ fees and all other costs associated with pursuing the claim are recognised immediately as an expense. This impacts operating profit for as long as the matter continues, may lower the chance to grow EBITDA if, due to the litigation, money spent on activities such as sales or marketing is reduced, and can reduce the market value of the company by a multiple of those costs.

As third-party funding removes these costs from the balance sheet, increased certainty over legal spending forecasts is obtained, and both the operating profit and valuation of a business may be improved. A business may also find its investors get comfort from the use of funding to shift the company’s litigation risk to a third party.

Other benefits can be seen where a funder is able to provide financing for historic or ongoing operational costs of the business, secured against the proceeds of one or more disputes. In this way a business can use funding for a range of business purposes, whether it is a necessary cash injection, debt refinancing, or simply capital or operational investments in the business.

Future trends

As we look ahead, there are many reasons to believe that the number of disputes involving corporates will increase. Our decades of collective experience at Harbour tell us that economic, geopolitical and regulatory volatility are key drivers of dispute volumes.

The pressure on businesses to move faster than ever before makes it more likely that legal issues will go unnoticed or unaddressed, for example as decision makers fail to involve the legal department early enough in decisions or new initiatives – if at all. Meanwhile new, unpredictable and unfamiliar risks will emanate from investments in new technology and markets.

This will push the pace of adoption of third-party funding by corporates even further, whether in its well-known single-case form or through other innovative products. This steady increase will also continue as knowledge grows among executives of the availability and benefits of funding. Finally, more law firms recognise that funding is a competitive advantage and driver of growth when it forms part of the conversation about fees, even with their well-resourced clients.