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What You Need To Know About Contract Risk

What You Need To Know About Contract Risk

from  March 22, 2023 | 5 min read

In B2B contracts, collateral damage can occur and problems are not always predictable. It is important that contracts proactively mitigate risk while minimizing any potential impacts. It is not possible to cater to all contract risks, nor should all risks be accommodated. Instead, the chances of particular types of contract risk need to be determined and options negotiated in the contract.

Direct Risk in Contracts

Being one of the most important types of risk to deal with, direct risk deals with the actual content of the contract. Here are some of the biggest direct risks that could be encountered.

Hidden Contracts

A large contract risk occurs when personnel don’t even realize a contract exists, what’s contained within it, or where it is stored. Therefore, as people don’t know pertinent deadlines or obligations, it’s possible for penalties to be enforced or even termination or auto-renew.

Operational Events Anticipated in Contracts 

Most modern contracts enable functions to flow smoothly by outlining the operational arrangements between various parties. However, if certain activities aren’t performed, this can result in contract risk.

These might include:

  • Providing key dates very clearly.
  • Implementing systems that can monitor supplier performance.
  • Providing for each party detailed obligations, and explaining the consequences of non-compliance.
  • Describing parameters and operating processes like placing orders, payment, or changing a contract.
  • Clauses for risk management surrounding force majeure, limited liability, dispute resolution, exchange rate management, or governing law.

Contracts That Don't Comply

Compliance problems can be a particularly strong burden on a contract. Typically, parties might have to comply with:

  • How information is protected in certain regions or countries, like GDPR.
  • Laws regarding the sale of certain goods for people in certain countries.
  • Laws for certain industries.
  • Certain ways of doing business which is accepted generally.
  • International standards like SOC 2 reports that control effectiveness.
  • Obligations.
  • Operating policies, practices, and processes for either party in the contract.

Contracts should clearly outline obligations that apply to both parties, whether they are joint or separate. This lowers the chance of arguments and therefore non-compliance risk that affects final outcomes.

Contract Management and Organizational Support

When it comes to the creation, implementation, management, termination, and renewal of contracts, many different parts of an organization are usually involved. They may contribute centrally—I.e., different parts of the organization feed into the agreement. 

Bringing in new business is always important, depending on the type of organisation, growth rate and age. This might be the focus, rather than merely managing what is already there. With a new organisation or one that lacks maturity, contract risk often follows. 

Contract Management and Lack of Awareness

A contract is not dissimilar to a form of transport. If it is not routinely checked or maintained, it will not operate correctly. In some businesses, a dedicated contract team might exist. For others, the task might be managed by legal or procurement teams. The latter could be because there is simply no need to have a dedicated team for this purpose or that the organization cannot see the benefits or purpose of having such a team. With this comes a problem, in that contract risk dramatically increases with a lack of awareness.

Contract Management Policies

Awareness and action are not the same things. Company activities require their needs backed by several different things. Policies should exist that explain both the ownership and purpose of activities, and strategies should exist that need to be followed closely. Documentation should exist that describes how to complete different activities correctly, while all actions should be categorized as being either optional or mandatory, to ensure contract risk is avoided. 

Effects of Poor Resourcing on Contract Management 

For a business function to deliver the right outcomes, it is essential for proper resourcing to be in place. This can include things such as ensuring the right level of funding, staff, training, buildings, and technology, amongst other things. If a business cannot operate properly, this will have consequences. 

Why a Contract Management Ecosystem is Important 

Everything vital to a contract always has to be present and available. All procedures must be followed closely, documentation must be updated appropriately, and if possible, a road test should be conducted to ensure everything works the way it should do.

Not having the right contract management ecosystem in place can be a source of contract risk. Suppose activities are too inconsistent, informal, or simply lack the right level of documentation. In that case, staff will simply do what they think needs doing, rather than follow a tried and trusted process.

Technology is essential for contract management. Without using it, important deadlines can be surpassed, undesirable contracts can auto-renew, and desirable contracts can terminate or revert to default conditions. In other words, without using automated software, staff can quickly fail to do what is required and generate contract risk.

Oppositely, with the right people, technology, and training, a robust contract management ecosystem can be designed and implemented. This way, the identification of contract risk becomes more straightforward and better managed.

The Most Important Things to Remember About Contract Risk 

  • Contracts need to be designed in the right way to minimize, prevent, or eliminate any type of contract risk.
  • Manually checking contracts for risks can be much work, demanding great effort from legal teams and contract specialists.
  • If legal staff aren’t available to check a contract, someone with the right attributes should complete the job.
  • Particularly, someone with a good grasp of English, a strong memory, and tenacity, amongst other things.
  • When contracts are viewed, they should be seen from the provider’s viewpoint. This provides insight as to where risks exist.
  • Someone new to contract review would benefit from being mentored by someone more experienced.

Dan Townsend

No Longer with Scanmarket

Dan has been a leading executive across all areas of Contract and Compliance Management applications since 2001 in both Sales and Implementation. Dan has over 30 years management experience in a wide range of business applications such as ERP Implementations, Business Process Reengineering, and Operations Management.