Proposals for a Definition and Map of Legal Risk

The mapping of legal risks is founded on a single major idea: it must be based on the potential consequences of legal risk in terms of value destruction, evaluated in three registers.

The mapping of legal risks is founded on a single major idea: it must be based on the potential consequences of legal risk in terms of value destruction, evaluated in three registers: strategic value (achievement of strategic objectives, reconsideration of a competitive advantage over the longer term, effects on the reputation of the company), financial value (costs, loss of profits over the medium or longer terms), and institutional value (impact on relationships with institutions and government authorities, as well as with such civil-society institutions as nonprofits, consumer associations, and so on). The identification of legal risks is the most complex phase. The basic tool for detection of legal risk is the definition of legal risk itself, which must be rigorous and practicable from an operational point of view. In this respect, we have come up with a definition/tool to which are inherent the principles of its use: Legal risk arises from the conjunction of a legal norm and an event, with either one or the other (or both) being characterised by a degree of uncertainty. This conjunction of a legal norm and an event in a context of uncertainty will have consequences likely to affect the value of the company. This proposal can be summed up in a three-part recommendation, the formulation of which is of interest in terms of communication: Look for the legal norm, look for the event, gauge the degree of uncertainty weighing on one or the other or on both: the norm, the event.
Our method of mapping legal risks is founded concretely on a continuum encompassing the following phases:

1. starting from the value chain of the business under consideration

2. a/ identifying the legal norms involved in each part of the value chain
b/ evaluating, in keeping with particular coding, the degree of legal uncertainty presented by the identified norm 

3. a/ identifying the factual events that may intersect the legal norm under consideration b/ evaluating, in keeping with specific coding, the factual degree of uncertainty presented by the identified event

4. identifying legal risk by crossing the results of phases 2 and 3 

5. evaluating the impact of legal risk on value.

This process was tested from an operational point of view (and can thus be illustrated) by going through the abovementioned phasesthat is, 1. -> 2. a/ b/ -> 3. a/ b/ -> 4. -> 5. This process was explored in the other directionthat is (as the order of the phases must then be revised): 5. -> 4. -> 3. a/ b/ -> 2. a/ b/ -> 1.
In other words, the proposals above mean that mapping legal risk can be done either forward or backwards. This leads us to propose two methods complementary methods or alternativesof mapping legal risk: the forward identification process, the advantage of which is its analytical nature, and the backwards identification process, the advantage of which is that it promotes the ranking of legal risks. 

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Proposals for a Definition...
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Type : Position paper
Date : le 24/06/2011
Extra information :

For more information, please contact Joanne Finlay, EDHEC Research and Development Department [ joanne.finlay@edhec.edu ]

The contents of this paper do not necessarily reflect the opinions of EDHEC Business School.

Research Cluster : LegalEdhec

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