Contracts, in all their varieties, are vital to the success and growth of every type of businesses. They are used to provide everything from basic services and materials to establishing partnerships and securing licenses.
Contracts also come with obligations and risks though, and assessing and managing that risk is crucial for gaining the best deals possible. In fact, if managed well, contracts can offer a great deal of protection from liability and risk. The internal drafting process and negotiation stages of the contract lifecycle present a natural place to perform risk assessment of contracts. This article will cover several strategies for performing risk assessment of contracts and best practices for mitigating those risks. Risks in contracts are often magnified by one central issue—a lack of transparency.
How Contracts Can Present Risks
Having a less than adequate amount of transparency for contracts can result in bad planning and demand management, overly complicated pricing structures, miscommunications, revenue leakage, overrunning costs, scope creep, etc. One of the riskiest outcomes of a lack of transparency and adequate review is that businesses may be obligated to a deal that presents a financial burden, and does not yield sought-after benefits.
The central function of an effective contract lifecycle management process is to help both parties collaborate on a beneficial deal so that risks and benefits are satisfactory to both parties. The first step in mitigating contracting risks is to have a good understanding of the parameters of the deal being contracted for and to understand the contract from all negotiation positions (e.g. what are all sides trying to protect against, are there particular timeframes in the performance lifecycle that are critical).
Reviewing the Contract
Identifying the risks which may arise over the course of a contract’s lifecycle requires experienced reviewers who carefully read the language of the contract to make sure that the contract language presents a fair deal.
Review the language of the contract. Does it fully express the risks proposed by the contract? This language will be found in specific contract parts such as the warranty and representation, default, and risk allocation clauses.
The best way to ensure that the contract language represents the inherent risks adequately is to have it reviewed by knowledgeable and experienced individuals with knowledge of both the organizational risk mitigation processes and drafting terminology. Such assessors should review the scope of the risks, evaluate whether they exceed the organization’s risk tolerance, and emplace financing and transfer mechanisms for any possible losses that may exceed the designated risk tolerance.
When performing risk assessment, look at the following elements:
- Regulatory and business risk factors.
- Risk to third parties.
- Contract assessment reviews.
- Review embedded options.
- Financial viability assessment.
Once contractual risk has been assessed, one of the best strategies for minimizing that risk is to implement risk transfer. A contracting guide put out by the Harvard Risk Management and Audit Services department describes risk transfer as “intended to assign responsibility (financial or otherwise) for associated risk exposures to one party or the other. Contractual risk transfer can relieve the person or organization originally responsible for the risk (the “transferor”) by assigning it to one or more of the contract’s counterparties (the “transferees”).” Risk transfer is accomplished through a combination of indemnification (hold harmless) clauses, limitation of liability clauses, and waiver of subrogation clauses.
Indemnification Clauses—Put simply, an indemnification clause allows one party to seek redress or monetary reimbursement which that party is required to pay to another third party as the result of an injury. This injury could be physical, but it could also be monetary, and caused by the same party from whom you are seeking redress. Indemnity is about moving liability to the party that was originally responsible for causing the injury.
Limitation of Liability—These types of clauses place a cap on how much exposure a company might face in the event of a claim made or action taken. These clauses most often reduce liability to the fees paid, a specifically agreed upon amount, insurance coverage available, or some combination of these factors. Having a limitation of liability clause has the potential of reducing a company’s exposure to risk by 90%.
Subrogation Waiver Clause—Subrogation pertains largely to insurance claims and is defined by Lee R. Rugg as “the principle under which an insurer that has paid a loss under an insurance policy is entitled to all the rights and remedies belonging to the insured against a third party with respect to any loss caused by a third party.” When insurance claims are made, the insurance company is subrogated, stepping into the shoes of the insured, to sue the third party for losses suffered by the insured. In other words, insurers make the insured whole through paying for damages, and then through subrogation can sue the third party who caused the initial damage, to make themselves whole.
Waiving subrogation removes the right, of in this case the insurance company, to sue the third party who had caused the damages to the insured. In addition to including these types of clauses in the contract language, it is advisable to carry commercial insurance to ensure that finances will be in place in the event of a loss.
Best Practices for Optimizing Contract Management Practices
Along with adding risk transfer clauses into an agreement, it is crucial to address the underlying cause that leads to so much contract risk—lack of transparency and collaboration. To enhance collaboration, treat contracts as representations of relationships, and not as text on a page filed away in a cabinet or closet. Engage with all potential stakeholders in an open way that enhances transparency and avoids risks that come from lack of communication and misunderstanding of contract terms. Review contracts often, and monitor performance. The easiest and most effective way to realize these best practices is to automate the contract lifecycle as much as possible through the use of contract lifecycle management software. Contract lifecycle management software offers a centralized platform that contains tools to automate and streamline the contract management process.
Concord is at the forefront of contract lifecycle management software. Concord addresses the central issue of contract risk by focusing on facilitating collaboration in the contract negotiation and management process, thereby enhancing transparency. This opens up channels of communication between colleagues, external stakeholders, and third parties. All of Concord’s features are built on the premise that the contract negotiation process is inherently collaborative. The tools that Concord provides which help optimize contract collaboration and communication, and thereby reduce risk, are:
Versioning Tools—In Concord, new versions of contracts are saved and displayed in chronological order next to the corresponding document. These records are permanent, and cannot be tampered with or altered. Concord keeps all versions clearly marked and centrally stored. This feature allows all parties to quickly and easily see that they are working on the most up-to-date version as well as the evolution of past changes to the document.
Discussion Panel—Concord’s discussion panel provides a medium through which parties can hold conversations about the contract. Having a discussion built into the contract platform itself eliminates the need for back-and-forth by email. With Concord, the discussion panel is always attached to the contract for a quick reference as contract terms are discussed.
Collaboration with Colleagues—Concord provides a central hub through which colleagues can collaborate together to produce a document draft. With Concord, a single draft can be worked on easily by multiple individuals in real-time, all the while Concord will keep accurate records of document versions and changes. After the draft is complete, users can invite external stakeholders for negotiation within the Concord platform.
Approval Workflows—Concord allows each document to have its own tiered approval workflow in order to ensure the appropriate team members are alerted to act at the appropriate juncture of the negotiation workflow. This greatly simplifies the collaboration process by automating and mapping out the actions needed to approve a document.
Clause Alerts—Users can configure clause alerts for specific events in the contract lifecycle, such as advanced notice of termination and contract renewal dates. Concord will send automated alerts via e-mail in advance of and on the date of a clause deadline, allowing users to appropriately prepare needed actions. Alerts ensure that crucial actions will not be missed or forgotten about, and keeps all parties involved and informed.
These tools provide the means to eliminate the back and forth exchanges that occur largely by email, resulting in multiple document versions in Word or PDF, and missed approvals in the negotiation workflow. To learn more about how concord can help reduce potential contract risks by enhancing collaboration, visit concordnow.com to request a demo.