Assessing legal risk-an investor guide

Open any annual report, and chances are that you would see a plethora of legal risks(here, legal merely means a violation of any contract/law, which is under dispute). An IIM-A Prof famously said 'law changes at the stroke of the pen'. That pen stroke can cost billion-just ask Vodafone, SKS Microfinance, Reliance Communiations, RNRL, Reliance Industries, HCC, JSW Steel etc-all victims of recent legal related issues.They may be

1. Tax related-that table you see attached to the audit report, listing the forum/subject matter/tax amount and period of the dispute. This may be related to direct or indirect taxes. While the company/its legal expert would ordinarily have evaluated the chances of winning before deciding to litigate, remember that companies starved  of cash flow may have little option, but to contest perfectly valid tax claims. While Vodafone TDS dispute hogged the headlines, there are many other disputes below the surface such as service tax on real estate, license fee for telecom, TDS issues for telcos/airlines etc
2.  Litigation related:- Companies typically wriggle out of disclosures when they are on the losing side by claiming the protection of 'sub judice' disputes. Still, where amounts at stake are signifc
3. Proposed legislation/Draft Reports:- It is sad that most investors/analysts may not bother to read the detailed draft/bill, but prefer to rely on the press release/some summary out there. Whether it be the Lokayukta reportwhere Sesa Goa crashed till it released clarifications), AP MFI Bill/Central MFI Bill(which lead to SKS microfinance stock see-sawing), mining bill(where mining stocks fell); market did overreact before sanity prevailed. For the recent bills(on ports, land acquisition) etc, this knee jerk reaction has decreased, maybe because noone expects these bills to be passed during the current log jam of Parliament. 
4. C&AG Reports:- Thanks to an activist C&AG, and a media hungry for that next soundbyte/breaking news, C&AG reports are the next source of fear for companies. Even a mighty giant like Reliance lost 10% due to a C&AG accusation of goldplating. Given this, what hope do others have? This, although actual legal action and enforcement would take years, due to which NPV would be lesser
5. Political:- The Mayawati Govt threw hurdles into RPower's projects in UP, thanks to his links with her rivals the SP. Mamta Bannerjee's Govt's first act was to confiscate the Singur properties of Tata Motors, which she perceived as siding with the Left.  When the DMK fell out of favour with the UPA at the centre, the AIDMK state Govt leapt on Sun TV like a hungry vulture. To keep Sharad Pawar's NCP toeing the party line at the state level, HCC's premier project Lavasa(where his shadow ownership is whispered about) was held up for months on environment grounds,  till court intervention. As infrastructure analysts would concur, projects(especially irrigation, roads) are doled out as rewards for electoral support-though the PPP framework is reducing this. 
6. Raids by income tax/labour inspectors/receipt of notices:- Satyam is fighting a case where the IT Dept has demanded thousands of crores of additional liability on (as per Satyam) non existent income. This would impact the valuation till the matter is resolved. People with legal flair can analyze and benefit. Also, at times, there are news announcement of 'search and seizures','surveys','raids' etc. One should note that unless the company is formally charge sheeted/arrests made/fines recovered, this news is as good as noise. 

Moral:- One can crystal out certain lessons from these sorry tales

1. Avoid a knee jerk reaction, and read the full bill/draft/details, and assess the probability of loss. This would need more than passing legal knowledge, so using an expert may help for important issues
2. Assess political leanings of corporates, as change of governments(more common in this coalition era) may turn corporate fortunes topsy turvy
3. Where a landmark tax verdict has been rendered, chances are that the next Budget will contain an amendment to reverse that favourable(to taxpayer) verdict with retrospective effect. This has happened for the offshore oils services income tax, cigarettes excise duty, lottery tickets service tax, realty service tax etc; and is likely to happen again. So hesitate before factoring in tax wins in the valuations.