Author Hanna Hasl-Kelchner says a lack of legal knowledge may be putting your business at risk.

Like it or not, businesses operate on a legal playing field—cross the foul line, and you may get sued, have a government agency fit your business with a regulatory straightjacket, or be forced to watch your business collapse in a bankrupt heap amid a public scandal and personal humiliation.

Legal missteps are incredibly expensive, yet mainstream management theory largely ignores the legal consequences of business decisionmaking. This is akin to doing a financial analysis without including tax considerations.

It’s time for businesses to get proactive and use the legal risk management process to their advantage. This requires management awareness of potential legal pitfalls at the beginning of their decisionmaking processes, not after things have gone wrong and the lawyers are called in to clean up the mess.

Legal literacy throughout the business value chain puts managers—not their lawyers—in the driver’s seat of legal risk management, driving down the burdensome costs of excess legal risk.

Truth of the matter
Many companies ignore latent legal risks in the belief that insurance is automatically available to pay their claims. True, insurance plays an important role in a company’s overall risk management program, but over-reliance on insurance as a risk management tool is a flawed strategy.

Employment practices insurance is a good example. It was first made available in the early 1990s as a way for companies to protect themselves against unwanted sexual harassment claims and other types of employment claims. Rather than changing the underlying behavior that could give rise to such a claim, companies turned to insurance as an affordable Band-Aid.

As insurance companies gained more experience with claims made under these policies, they learned harassment claims were more serious and more frequent than expected. The average jury verdict was more than $1 million. As a result, some insurers stopped underwriting such policies; the rest passed their costs through by doubling or tripling their premiums. As employment practices coverage became less affordable, companies were forced to reevaluate and address the problem’s root cause. Compliance programs developed teeth, and risk was controlled and reduced, rather than buried.

Risk and the cost of insurance go hand in hand—the higher the risk, the higher the premiums. Unlike other goods and services, insurers do not offer volume discounts to policyholders with massive claims histories. Instead, they increase your premiums or drop coverage altogether.

Often, businesses are forced to sue their own insurance companies to recover a legitimate loss. Furthermore, insurance does not protect an organization against all losses because some risks are simply uninsurable.

Perfect timing
Legal risk is not a random event—it can be anticipated and mitigated. Timing is key: the longer you wait, the less options are available, and rather than helping to shape the facts as they unfold, you’re forced to play the hand you’re dealt.

If you want to win from the beginning, you need executives and managers to take greater ownership of legal issues early in the decisionmaking process. Employees are strategically positioned in the organization to avoid or minimize the vast majority of organizational legal problems simply because they are the decisionmakers.

The legal literacy of all employees, from entry level to senior managers, plays a role in a company’s ability to exercise legal leverage. Employees shape the deals at each step of the value chain and create the goods or services on which the enterprise is based, and they know what is going on long before the lawyers.

Even seemingly routine decisions can have a disproportionate impact on the organization. For example, a simple software agreement can present a serious business threat if the software happens to play a critical role in your business. Vague warranty language leaves you without recourse if defects crash your servers, strangling your daily operations.

One manager believed his contracts were fairly standard until a simple business transaction went wrong, developed legal implications, and posed operational risks and financial implications. Connecting the dots from a boilerplate contract to profitability motivated him to negotiate the deal further. Rather than glossing over ambiguous or unfavorable contract language, he sought clarification with the vendor and avoided the kind of misunderstanding that could have escalated into conflict or a lawsuit.

By managing expectations at the beginning of the transaction and reflecting them in the contract, he reduced unwanted legal risk while maximizing business objectives. He negotiated a fairer deal, transforming potential warranty liabilities into an asset. Legal literacy broadened the manager’s frame of reference, giving him leverage and leading to more protection for the company and a better deal.

Organizations are ripe with opportunities for small, highly targeted changes that can make a huge difference in the company’s legal risk profile. Once you find and prioritize them, you maximize the return on your training dollar by cultivating legal literacy where it’s needed most. When used strategically, legal literacy helps maximize business opportunities while minimizing unwanted risk, a legal sweet spot.

Hanna Hasl-Kelchner is the author of The Business Guide to Legal Literacy: What Every Manager Should Know About the Law (Jossey-Bass, 2006). See her blog at www.legalliteracy.com.