Managing Contingent Liability of Litigation and Pending Claims on a Company's Books

In a constantly evolving and complex business environment like ours, it is inevitable for going concerns to find themselves engaged in one commercial dispute or the other. These disputes can be difficult, expensive, and time-consuming for all involved. If not anticipated and properly managed, all these have the potential to result in a downturn on the company’s finances. For small companies that have limited operating budgets, the effects of a time-consuming, costly lawsuit can be disastrous. The management of contingent liabilities like pending litigation claims is therefore necessary for preventing the far-reaching negative impact on the company’s outlook.

A?classic example of a pending litigation on contingent liability is the reported lawsuit instituted by the people of Bodo Community against Shell Petroleum Development Company (‘SPDC’) for compensation for losses suffered to their health, livelihood, and land, and also demanded a clean-up of oil pollution in the community. Even though SPDC eventually agreed to pay the sum of ￡55,000,000.00 (Fifty-Five Million pounds) for the clean-up of the community, while the community agreed to put the case which is before the London High Court on hold, the claim remains hanging on SPDC and its attempt to strike out the suit was refused by the court in 2018.

Even with an out-of-court settlement, the prospect of chalking off the sum of ￡55, 000, 000.00 from the company’s books is better imagined. Cases like these highlight the need to proactively deal with contingent liabilities with its attendant consequences on the company’s books and finances before they develop into full-blown litigation. The thrust of this article, therefore, is to expound on contingent liabilities, its effects and how it can be managed.

What is a Litigation Contingent Liability?

“Contingency” literally can be defined as a future event or circumstance which is possible but cannot be predicted with certainty. From a commercial point of view, it is defined -according to Financial Accounting Standards Board (FASB)- as an existing condition, situation, or circumstances involving uncertainty as to possible gain (“Gain contingency”) or loss (“Loss contingency”) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur. The resolution of the uncertainty may confirm the acquisition of an asset or the reduction of liability or the loss or impairment of an asset or the incurrence of a liability. Some examples of contingent liabilities include pending litigation (legal action), warranties, customer insurance claims, and bankruptcy.

Managing Litigation Risks Thorough Due Diligence

Having identified the near inevitability of lawsuits, it is pertinent to identify the various exercises of due diligence to be undertaken by the company at different levels to mitigate the ravages of these contingent liabilities. Whilst these exercises are by no means exhaustive, they provide valuable pointers to the proactive steps that companies must take to reduce the chances of avoidable litigation. These steps are outlined hereunder as follows:

• ·???????? Staff Training and Corporate Culture

Some companies have been known to engage in hasty commitments without proper due diligence and thorough contract review. The implications for the company’s finances can be dire. The management team must appreciate the value of contract review and due diligence, and put in place internal litigation risk review procedures for approving transactions. The in-house legal personnel in the company must be trained to appreciate legal principles and relevant current decision, and identify the latent risks in such transactions. These processes are not a deadweight, but an investment that delivers tangible value to the company’s business, over time.

• ·???????? Proper Documentation

Companies need to keep proper records of all correspondences, transactions, and agreements with third parties. These documents form the basis of disputes in most cases, and the ability to produce any of such documents can terminate or prevent litigation or pending claims. Companies should also ensure to put into writing any form of a transaction entered between it and third party, no matter how trivial it may seem. The management must put in place a proper record keeping policy that ensures that its most important documents are not lost or destroyed.??

• ·???????? Due diligence on counterparty risk

Experience has shown that businesses focus more on the juicy details of prospective contractual engagements with scant regard for the risks posed by its association with the counterparty. Apart from the financial and technical capabilities of the counterparty, companies must ensure that there is alignment of values, gauged by the counterparty’s displayed behavior. Problems can be particularly acute where the arrangements presuppose a level of goodwill or confer discretions that can be used as an effective veto or as a means to hold the company to ransom. If need be, adjust structures or contractual terms to provide additional protection.

• ·???????? Contract management

When negotiating, companies should pay close attention to deadlines, performance standards, deliverables, termination rights, representations and warranties, indemnities, exclusion clauses and limitations on liability. These are common areas where disputes arise.

• ·???????? Consulting Legal and Financial Experts

When it comes to managing contingent liabilities, experts need to be consulted as early as possible. In-house counsel should seek the advice of external counsel on transactions and documents to obtain the seasoned legal opinions. Financial and legal experts can also come up with a standard procedure for companies to adopt in avoiding contingent liabilities. There are many regulations or procedures that companies need to comply with, and an expert could ensure early compliance with these regulations.

• ·???????? Insurance

Companies should conduct an audit of their business coverage to identify risks to which they are exposed and negotiate the best possible tailored policies with insurance companies. It is equally important to conduct a review of the terms of the policies to ensure adequate coverage.

Early Stage Mitigation

Our discussion above has elaborately highlighted the proactive steps to take to ensure litigation does not arise. Where litigation does arise from the acts or omissions of the company or its agents, companies should adopt an approach that encourages an amicable out-of-court settlement. This is because it is easier to manage disputes at its early stage than to allow the issues fester with the possibility of developing into public, protracted, and hostile litigation. This will put the opposing party at ease and ensures that the company does not cede its bargaining power to the counterparty.

Conclusion

Contingent liabilities such as litigation and pending claims are avoidable but can be effectively managed. Therefore, companies need to devote more time and resources towards preparing to avert or mitigate the risks that may arise from these claims to ensure that the company’s finances and reputation are protected at all times.