Successful legal entity management yields benefits for companies

Lucy TrevelyanThursday 16 June 2022

As a new report highlights the importance of implementing solid legal entity management practices, In-House Perspective examines what good practice in this area means for in-house teams.

Companies that implement leading legal entity management (LEM) practices deliver better business outcomes and are more confident of being able to comply with rising multiple-jurisdiction regulatory requirements, according to a new report.

The study – entitled An Inside Look at Legal Entity Management Practices – was conducted by the Association of Corporate Counsel (ACC) and Deloitte Tax and published in April. It found that LEM, which consists of the management of the books and records of a company’s various legal entities, was regarded as increasingly challenging by most of the 520 organisations surveyed.

The main challenge faced by LEM teams is that of competing priorities within the organisation, according to 71 per cent of participants, while a lack of bandwidth (49 per cent), inconsistent processes (40 per cent) and antiquated LEM processes (31 per cent) were all also listed as major hurdles for the LEM function.

In today’s globalised world, multiple jurisdictions always pose challenges to effective LEM, particularly given the different levels of compliance required in various jurisdictions, the absence of uniform regulatory requirements and the fact that punishment regimes are different in various jurisdictions, says Abhijit Mukhopadhyay, Committee Liaison Officer on the IBA Corporate Counsel Forum and President (Legal) & General Counsel at London-headquartered Indian conglomerate the Hinduja Group.

‘Multi-jurisdictional businesses always pose challenges,’ he says. ‘Entities need to run a strict compliance and governance protocol to avoid reputational and financial damage, including penalties. Effective LEM involves a rule- and protocol-based approach which is the key to institutionalised entity management policy. However, proper monitoring of such policy is also key. There has got to be an effective reporting system to ensure systematic monitoring and identification of non-compliance, in order to take remedial action wherever necessary.’

Technology is ‘critical’ for the effective management of LEM practices, the study states, and indeed, respondents reported that technology to manage LEM is widely used, with 60 per cent of participants saying they use an electronic database to track corporate records. However, 73 per cent said they are dissatisfied with or neutral in their view towards their current technology.

In addition to the digitisation of records and database management, technology is critical for in-house teams to stay current as to the latest regulatory and compliance developments, says Sapan Gupta, Group General Counsel at steel production company ArcelorMittal.

‘Technology that enables in-house legal teams to stay up-to-date on matters of regulatory significance and on changing compliance requirements globally will be as relevant as technology that enables teams to have access to prioritised information that is relevant to their groups/practice areas specifically,’ he says.

Ultimately, Gupta adds, boosting an organisation’s ability to track, and have easy access to, regulatory updates will ensure that the company is able to stay in timely compliance with regulatory requirements.

He says that easily navigable electronic databases that are regularly updated, freely accessible organisational and corporate structure charts and organisation-wide reminders of relevant compliance deadlines, are some measures that are indispensable for ensuring proper management of complex compliance and regulatory obligations.

Although 22 per cent of departments expect an increase in LEM staff this year and 39 per cent reported an increase in the LEM budget in the past year, only around half of departments are currently satisfied with company leadership being sufficiently attuned to the organisation’s subsidiary management processes.

For effective implementation, impetus from the top and the creation of an organisational ethos are necessary, Mukhopadhyay says. ‘The most important parameter is the willingness and support from the top without any compromise. It should be understood that good compliance and effective governance are equivalent to good and profitable business.’ 

Although more than half of the study’s respondents (56 per cent) do not conduct any internal audits or regular monitoring for LEM practices and procedures and 40 per cent of departments do not have a compliance calendar to track corporate entities' records, three-quarters of participants are at least somewhat confident in their organisation’s ability to stay in compliance with regulatory changes.

Well-composed LEM policies and ensuring that the procedures put in place by these policies are followed by the legal function of an organisation as a whole, is critical to the legal function acting as a streamlined unit, says Gupta. ‘Additionally, it is imperative for the LEM function to conduct routine audits and monitoring to ensure that the policies in place are current and being utilised effectively, and that these meet the organisation’s requirements,’ he says. 

Inconsistent policies and standards across regions are a cause of concern for large organisations, as is the difficulty of overhauling antiquated processes that are no longer efficient. ‘Appropriate and modernised LEM structures being in place are critical for regulatory compliance, legal entity governance and lead to fewer issues, particularly due to scattered and antiquated processes,’ he explains.

Failure to put in place proper LEM policies and procedures creates both regulatory and litigation risk. ‘Issues will inevitably slip through the net,’ explains Elaina Bailes, a partner at Stewarts Law in London. ‘For example, if a subsidiary fails to comply with local law and regulation, as well as facing regulatory penalties this may cause the group to be in breach of contractual warranties or covenants in finance documents. This may lead to counterparties being able to declare events of default and pull financing.’

Large businesses now have an increasing focus on environmental, social and governance (ESG) reporting. Companies could therefore also see challenges from their shareholders and customers if there are failings in their group corporate governance, says Bailes. ‘Where businesses do not have an adequate handle on their legal entity structure, it leaves the possibility that unethical practices ranging from greenwashing to bribery and corruption will go undiscovered until too late,’ she explains.

Fast-moving geopolitical events are rapidly having an impact on the course of organisations, while increased regulatory scrutiny has been felt by companies globally over the past few years. Strong LEM practices are thus nothing short of imperative for large organisations, concludes Gupta. ‘Strong LEM structures ensure that in-house legal teams across an organisation are equipped with updated tools to assist the business functions effectively, regardless of geography or the size of the organisation,’ he says.