Global Disclosures: Litigation Risk

April 30, 2010

For most U.S. trained attorneys, it probably doesn’t come as a surprise that even the mere possibility of litigation should be disclosed somewhere in a company’s annual report, writes Jesse R. Morton of Thomson Reuters Westlaw Business Currents. (Click here for further information.) But for attorneys preparing an annual report for a foreign filer from a less litigious country – basically every other country – take note this 20F/40F season: companies are erring on the side of conservatism when it comes to litigation risk.

Companies from camera manufacturer Canon to mobile phone manufacturer Ericsson to Norwegian oil company Statoil are disclosing risks ranging from IP litigation to uncertainty in certain target markets, to dealing with wrongful termination allegations. While litigation disclosures are certainly not a one-size fits all, below are a few of the themes rising up through this 20F/40F filing season.
General litigation risk disclosures come in every shape and every size, but pretty standard is from Italian oil and natural gas company Eni SpA. In their recent 20F, however, they stated that lawsuits are an ordinary occurrence in their line of business. A similar disclosure appears in the recent annual report from Newfoundland-based Canadian mineral royalty company Terra Nova Royalty Corp.
And although materiality should play a factor in determining whether to disclose, every lawsuit should be reviewed to determine the potential impact. A prime example is British Columbia, Canada-based Chai Na Ta’s recent admission that the company became involved in a lawsuit related to an automobile accident. Although the company believes that insurance will fully indemnify the company, the disclosure serves as an example that no rock should remain unturned in the quest for transparency. Likewise, Norwegian Statoil discusses in detail two lawsuits, one of which it explicitly states the financial impact is immaterial.

Intellectual Property
IP related litigation risks have been spotted in many an annual report, both from domestic companies and foreign filers, and the company concerns appear to be nearly identical regardless of domicile. The cases themselves often read like a 1L case brief. What is important (as perhaps Goldman can now attest to) is the mere effort of disclosure.
Common IP litigation risk disclosures are seen in annual reports from companies like UK medical device manufacturer Smith & Nephew, which merely states that the company is involved in several patent and license related lawsuits and provides a brief background and description of each proceeding.
A similar disclosure is found in the legal proceedings section of Japanese camera and electronics manufacturer Canon’s 20F, with the only difference being that Canon discloses three lawsuits, two of which are in Germany and one in Japan. Also standard is a disclosure that results of litigation are uncertain and occasionally result in materially significant losses.
Perhaps more ominous is a recent disclosure by Taiwan Semiconductor Manufacturing, which disclosed its concerns of a recent rise in IP related litigation. Of special concern, are claims by so-called “patent trolls”, non-practicing entities which merely aim for large settlements and “threaten[] to disrupt the legitimate business operations of profitable enterprises.” For more detailed information on IP litigation risks related to patent trolls, see recent Westlaw Business Currents articles 10-K Disclosures: Wielding the IP Sword, Hiding Behind the Shieldand Trolls Under the Bridge: IP Disclosures, a 10-K Must Have.

Developing Legal Regimes
Another similarity between U.S. filers and their foreign counterparts is uncertainty over the domain and enforcement in foreign legal regimes. Particularly prominent in this area of disclosure are statements related to operations in China, Russia, Brazil, and other developing but economically promising countries.
Consider, for example, real estate service company E-House (China) Holdings, which disclosed general uncertainty in China’s legal system, which does not have a “fully integrated legal system and recently enacted laws.” More detailed on the matter, though, are Chinese hotel owners and operators 7 Days Group Holdings and Home Inns & Hotels Management. Both companies provide in their recent 20Fs an ad nauseum description of the issues they’ve faced as a direct result of the Chinese legal system and its perceived lack of dependability. In its own words, 7 Days Group Holdings states that “[t]hese uncertainties could limit the legal protections available to us and our foreign investors, including you.”
Environmental
The environment, especially these days with the daily reports and Congressional hearings on global warming (or cooling, whichever is proscribed), pollution, and the thinning of the ozone layer, is a particularly sensitive issue over which there is an abundance of regulation. Therefore, not surprisingly, many disclosures feature discussions of regulatory-related litigation over potential environmental wrongdoings. Given the nature of aforementioned Emi SpA’s business, it’s perhaps not surprising that a recent disclosure expresses particular concern over losses stemming from environmental regulatory authority related litigation. Indeed, the company states that because of uncertainties surrounding such litigation, they account €372 million for probable losses arising from such actions. While most of that provision is for one particular case with a U.S. authority, that’s no small change, and the company expresses concern over more similar losses.
China-based Gushan Environmental Energy, perhaps not holding up to its name, discloses a whistleblower who alleged that the company was engaging in dishonest financial reporting and environmental protection. Although an internal investigation found no wrongdoing, the company states that such allegations often result in negative publicity, increased regulatory scrutiny, and possible ensuing litigation.

Antitrust
Although antitrust litigation is, relatively speaking, rare, companies that are in industries that have high barriers to entry, are extremely price sensitive, or have few competitors are certainly more prone. Not to mention that a full blown antitrust suit can be timely and costly.
The steel industry is a prime example of recent antitrust concerns, and Gerdau Ameristeel Corp, the American branch of Brazilian steel producer Gerdau S.A. disclosed ongoing litigation relating to a September 2008 federal investigation. According to the disclosure, federal authorities allege that the company, along with other defendants, “conspired to fix, raise, maintain and stabilize the price at which steel products were sold in the United States by artificially restricting the supply of such steel products.” The company vehemently denies any wrongdoing and discloses its belief that the allegations are meritless, but nevertheless, still cautions that the outcome is unpredictable and because of treble damages sought, may result in a material loss to the company.
Class Actions
Even foreign filers are not immune from the relatively unique U.S. procedural class actions, although given the sum of a few of the more notorious judgments, surely they all wish they were! Amongst those involved in a dreaded class action are Britain’s Aviva and Ericsson, the latter of which names two lawsuits in which they are involved – one related to an alleged securities law violation and the other related to the potentially adverse health effects of prolonged mobile phone usage. The former was dismissed and the latter the company received a favorable opinion but is still pending an appeal. Even so, the company discloses both lawsuits, and the potential financial impact.

Tax
While the IRS is probably not the favorite governmental agency of any tax-paying, red-blooded American, the sentiment appears to be commonly shared with our brethren from overseas and their overseas regulators. At least that’s what one might conclude given the number of foreign filers having issues with various tax authorities.
Nassau- based Ultrapetrol Bahamas, for example, discusses legal issues and lawsuits with Brazilian Custom Tax Authorities, Paraguayan Tax Authorities, and Bolivian Tax Authorities. Russia’s Wimm Bill Dann Foods also discloses a recent lawsuit over recovery of VAT. Lastly among our examples, previously mentioned Ericsson states that Swedish fiscal authorities disallowed certain deductions which the company continues to dispute.
Wrongful Termination & Employment
While wrongful termination and other employment related lawsuits are not uncommon in the U.S., it is generally the case that employment is at-will and employers generally have the upper-hand. Even when that is not the case, rarely does a judgment turn out to be material enough to warrant disclosure in a company’s 10-K. But that is oftentimes not so in many countries operating outside of the U.S., as many regimes grant generous benefits to employees. Accordingly, wrongful termination lawsuits often are disclosed in U.S. 20/40Fs. For example, Aegean Marine Petroleum states that a former director of one of its Ghanaian subsidiaries sued for wrongful termination and seeks damages of nearly $7 million. Similarly, Gamecorp discloses a lawsuit by a former employee who is seeking punitive damages and costs. Rarely do these suits amount to more than (relatively) small settlements, but when they do, they can be costly to both finances and reputation.

Conclusion
Litigation risk is always a touchy subject, both from a legal and from an accounting standpoint. That is because companies, generally, are confident in their legal position and oftentimes genuinely believe that they will prevail in their legal proceedings. Much to the chagrin of counsel, some companies assume a best case scenario or paint a picture that may turn out to be too rosy in their disclosures. And accounting guidelines require that companies disclose risks both in the MD&A and account for such litigations if the loss (or gain) is probable and estimable. The flipside is that if a company paints a doom and gloom scenario, it could mean disaster for management, or even worse…stock price declines. Make no mistake about it—disclosing litigation risk is not an exact science, but as the plethora of examples show, erring on the side of disclosing may be the key.

473 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

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