Legal Audit: Precaution is better than Penalty

In Depth

Legal Audit: Precaution is better than Penalty

Kailash Jeenger | August 2013

INTRODUCTION

The formation of a company, a firm or an entity similar in nature is bound by a number of aspects. Individuals and other persons associated with it in various capacities like employees, shareholders, partners, banks, contracting parties in business and the society in general become a part of it. At the same time, such an entity comes under a gamut of laws that regulate its functioning and safeguard the interest of those associated with it.

Compliance with the Companies Act, SEBI guidelines and laws revolving around labour, taxing and environment are not just part of good corporate responsibility and governance but ensures transparency and protection of investors. Compliance with laws is a matter of honest practices which, if not performed correctly and timely, may invite penalties. To ensure such compliance and safeguard a company against untoward incidences, a technique known as ‘legal audit’ can be adopted.

LEGAL AUDIT

Generally, an audit is a process of evaluating books of accounts. Legal audit, however, is an assessment and appraisal to ensure due compliance with various laws and regulations applicable to companies. The requirement of disclosure is important at many stages in every business — compliance, for example, is needed in case of issue of prospectus, conversion of public company into private or vice-versa, amalgamation, merger, meetings, alteration of memorandum or articles of association, issue of debentures, safety and health regulations etc. A diligent and prudent legal audit can be carried out at frequent intervals taking into account existing corporate laws, taxing laws, labour laws, statutory levies and environment laws, among others.

Legal audit, by warranting due compliance, reduces the risk of unnecessary litigation and imposition of fine and penalties to ensure smooth running and growth of a concern. An independent legal audit establishes trust in a company as it reduces legal liabilities against it.

IMPORTANCE OF LEGAL AUDIT

LEGAL AUDIT IS SIGNIFICANT FOR A NUMBER OF REASONS. LISTED BELOW ARE A FEW

Ensures corporate responsibility
Ensures applicability of variety of laws applicable to a company
Is in interest of public in general who can be attached to the company in the form of shareholders, resulting in constant watch on its actions by government, nongovernmental organisations etc.
Ensures plethora of SEBI guidelines are followed by companies
Compliance as a sine qua non many a times while trading with foreign firms
Requirement as to submission of compliance certificate by listed companies to the stock exchange

WHEN TO CONDUCT LEGAL AUDIT

Legal audit should be made part of routine business of every company like a health check-up is for an individual. Though it depends upon the size and type of business, legal audit should be conducted every two or three years. Most importantly, legal audit should be conducted as soon as any legal lacunae are discovered or suspected as it will enable the concern to take immediate remedial steps and the legal liability will be avoided or minimised as in case of many such faults, the penalty increases per day.

AREAS TO AUDIT

Proper documentation for the nature of company as it varies, as in case of private and public company
Registration of partnership firm
Licence for industry, factory or manufacturing unit
Modes of litigation planning
Compliance with labour laws with respect to the working conditions, harm during the course of employment, health insurance, retrenchment etc.
Compliance with environmental laws
Submission of various documents by companies to the Registrar of Companies and regional director
Intellectual property of the concern
Product liability

LEGAL AUDIT MECHANISM

FOR SMALL CONCERNS

Determination of audit goals
Determination of goals and scope of audit are primary steps for legal audit. It is necessary to correctly identify audit goals and the scope which can be spotted from previous legal matters of the company, the operations drawn in, potential future legal matters, and routine legal issues in the concern.
Preparation of compliance audit checklist
It deals with identification and determination of laws that are applicable on the target concern. The plethora of such laws may include corporate, labour, taxing and environment laws. It, however, shows only direction to the audit team to proceed. The contents of the checklist can never mean to be exhaustive. Before or after preparing the checklist, the audit team can ask for related documents or information from the management.
Meeting with senior managerial Officers
After getting the requested documents and reviewing them, the audit team deliberates with the management of the company and fills up the checklist. This should be done in the presence of the legal advisors and the secretaries of the concerned company.
Preparation of non-compliance list and talk with concerned person
Making observation and recommendations
After the meeting, the team studies entries made in the checklist and the documents submitted by the concern to find out to the extent to which the company has complied with the applicable laws. It identifies the budding legal liability of the concern and suggests ways to get rid of it.
Audit report
The final report should contain status of compliance and non-compliance of the company concerned. It should highlight the legal liability, legal errors in papers or agreements etc. and possible solutions to cope up with the risk involved. The report should categorise the contents of the list of non compliance according to their gravity and repercussions as some may threat the establishment of the concern directly, some may invite criminal prosecution while some may simply be punished with penalties. The report containing the findings and recommendations is an important document for the company, which should duly implement the recommendations made by the legal audit team.

For large concerns

Determination of audit goals
(same as in small concerns)
Initial questionnaire
If the target company is larger, a separate questionnaire can be prepared for each department or division of the company which can be distributed to the head of the division concerned coupled with a request for documents and papers needed for review. The separate questionnaire should be prepared carefully after considering the type of division, the laws which are applicable to it and the compliances required.
Review of responses and interview with managers individually
After receiving the replies and documents, the audit team prepares a primary observation about the legal compliance made by the concern. The team can verify the entries made in the questionnaire with documents supplied to it. Besides, deliberation with appropriate persons helps to reach concrete findings if the replies are ambiguous or the team needs more information.
Preparation of non-compliance list and talk with head of the concerned division
Conference with the senior officers
After analysing the responses the team interacts with all the managerial personnel of the concern and deliberates on the replies made by them. It helps determine the legal compliance of the concern as a whole. The legal advisors and the secretaries of the concern should be present there.
Making observation and recommendations
(same as in small concerns)
Audit report
(same as in small concerns)

POST LEGAL AUDIT STEPS

After a legal audit, the responsibility of a concern does not come to an end. It rather begins. The concern should formulate a plan with the help of apt persons to implement the recommendations made by an audit team. The steps to correct noncompliance and implement the recommendations mentioned in the audit report should be taken according to the categorisation made in the report. Most serious and endangering non-compliance should be corrected on primary basis, followed by the rest. In case of large concerns, the concerned division of the same should be consulted and asked to implement the recommendations.

FOLLOW UP BY AUDIT TEAM

After submitting the audit report, it is mandatory that the audit team checks after the stipulated or reasonable time if the company concerned has implemented its recommendations successfully. It can consult each concerned department also for the purpose and can help resolve any problem encountered by the concerned division while implementing the recommendations.

ADVANTAGES OF LEGAL AUDIT

Reduces potential legal liability.
Improves the efficiency and outcome of a concern or a division thereof.
Update of documents, registration, policy etc of a concern.
Facilitates good corporate governance.
Establishes and increases trust and credibility of a concern.
Protects public interest as well.

CHALLENGES BEFORE LEGAL AUDIT

Lack of cooperation of the divisions of the target concern or its officers.
Chances of manipulation in documents and concealment of facts.
Confidentiality of information is at risk.

CONCLUSION

In the era of complex legal environment and competition, companies have to be very vigilant towards regulatory laws. A minor mistake can result in heavy penalties and affect businesses. to avoid such a scenario, it is always better to take precautions and conduct legal compliance audit so as to ensure due compliance with laws, which in turn results into smooth running of business and good corporate governance.

About Author

Kailash Jeenger

Kailash is Lecturer at Govt. Law College, Nagaur, Rajasthan