Commercial Contractual Risk Management

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COMMERCIAL CONTRACTUAL RISK MANAGEMENT

In your commercial domestic or international contracts management activities supporting the seller or buyer of products and/or services, it is likely nowadays that you will be asked by your employer to review, analyze, evaluate, and possibly manage the contractual risks of an agreement pending the execution of that agreement by an entity. In my contracts management career, I have performed such a contractual risk management review many times. The purpose of this article is to provide you with some simple, practical, and useful information about contractual risk management that you can use as you engage in commercial contractual risk management activities.

BACKGROUND:

Companies and other entities must take contractual risks. Some of those risks are legal risks (like claims, warranty problems, default terminations, intellectual property infringement charges, alleged confidentiality disclosures, disputes, and litigation) and some are business risks (like poor relationships, failure to obtain objectives, bad public relations, declining morale, instability, weakening of brand integrity, loss of goodwill, and reduced revenue or profits).

DEFINITION OF COMMERCIAL CONTRACTUAL RISK MANAGEMENT:

Commercial contractual risk management certainly involves the calculated actions to reduce the severity, frequency, and unpredictability of damages, loses, and claims. However, it also involves (to some extent) managing the occurrence of those other negative business events. Such risks could be anything that threatens business operations. Contractual risk management can be strategic (systematic and on-going) or operational (single transaction).

WHO NEEDS TO KNOW ABOUT COMMERCIAL CONTRACTUAL RISK MANAGEMENT ?

Sellers, buyers, licensors, licensees, lessors, lessees, and any other party to a commercial agreement need to understand and practice good commercial contractual risk management. To survive and thrive in today's challenging business environment, all contractual parties need to increasingly make contractual risk management a high priority.

BENEFITS OF COMMERCIAL CONTRACTUAL RISK MANAGEMENT:

Effective contractual risk management often results in protecting assets, improving stability, improving long term profitability, safeguarding business reputations, reducing insurance claims (as well as reducing premiums), and guarding future opportunities. It provides a clear structured approach in addressing contractual risks. Also, it is quite cost effective in saving resources such as time, assets, income, and people. Contractual risk management should be practical, proactive, systematic, and be an integrated part the entire risk management activities of an entity.

EIGHT STEPS OF COMMERCIAL CONTRACTUAL RISK MANAGEMENT:

Typically, commercial contractual risk management involves: (1) first identifying contractual risk management issues using an appropriate multi-domain team [i.e. business, operations, sales/marketing, technical, contracts, legal, finance, etc]; (2) evaluating/estimating contractual risk management issues [i.e. likelihood of risk and consequences of risk]; (3) risk avoidance [i.e. rejection of certain types of high risk work, if appropriate]; (4) risk reduction [i.e. selection of lower risk clients that are financially sound and non-litigious as well as selection of lower risk projects, if appropriate]; (5) risk sharing by outsourcing or insurance; (6) risk mitigation by avoidance, elimination, transfer or bearing the risk, if appropriate; (7) monitoring/controlling risk; and (8) consistent use of well-prepared agreements/contractual provisions.

THREE ASPECTS OF COMMERCIAL CONTRACTUAL RISK MANAGEMENT:

Such risks can often be contractually managed to acceptable levels by using: (1) professional contractual provisions suitable to the applicable agreements and good contracts appropriate to the need; (2) good contracts management technology; and (3) appropriate contractual risk management processes. .

TOP TWENTY COMMERCIAL CONTRACTUAL RISK MANAGEMENT PROVISIONS:

Of course, all aspects of an agreement can affect commercial contractual risk management; however, here are [in my opinion] the top 20 commercial contractual risk management provisions of an agreement:

(1) statement of work (See: http://www.ncmahq.org/files/Articles/9BAF4_CM0807_C02_p58.pdf) and contract type;

(2) monetary cap on liability;

(3) exclusion of consequential and incidental damages;

(4) indemnifications [i.e. intellectual property and general indemnities] (See: http://www.ncmahq.org/files/Articles/84698_CM0307_C02.pdf );

(5) insurance and bonds (bid, payment, performance, warranty, etc.);

(6) warranties;

(7) standard of care [service levels] (http://www.ncmahq.org/files/PDFs/CM_Apr08_p64.pdf);

(8) termination [for default and for convenience];

(9) confidentiality ( See: http://www.ncmahq.org/files/Articles/F5BC2_CM1106_-_C05_Back-To-Basics.pdf);

(10) intellectual property allocation and work product use/ownership;

(11) force majeure;

(12) antitrust compliance;

(13) international trade compliance;

(14) contract type [fixed price, time and materials, etc];

(15) dispute resolution;

(16) price, payment, and revenue recognition;

(17) delivery and acceptance/service level agreements (See: http://www.ncmahq.org/files/PDFs/CM_Apr08_p64.pdf);

(18) quality;

(19) choice of law; and

(20) assignment, written modifications only, and entire agreement.

The language in each of these provisions needs to be very carefully crafted to insure contractual risk management. Attention must be given to the contractual and legal substance of these provisions as well as the form and format of the language of these provisions. Both are important (See: http://www.ncmahq.org/files/Articles/B50B6_CM_Apr06_p62.pdf).

CONTRACTS MANAGEMENT TECHNOLOGY:
Technology certainly has its place in contractual risk management. It is often a very quick return on investment to use one of the better contract management software products to assist with contractual risk management. Contract management software (whether hosted at your entity or set up as a SaaS/ASP on the web) can typically scan, centralize, organize, search, track/monitor, and archive contracts. It can help to reduce risk with contract and amendment creation, changes, subcontract monitoring, contract compliance, budgets, financial tracking, checklists, calendars, tickler reminders, email alerts, scheduling, tracking deliverables, and generally provide cradle to grave contracts management services that will reduce and manage contractual risk.
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COMMERCIAL CONTRACTUAL RISK MANAGEMENT PROCESSES:

Creating, maintaining, and improving good commercial contractual risk management processes such as use of good checklists, consistent use of contract management best practices, on-going use of risk status scorecards (red, yellow, and green), and application of other commercial contracts risk management processes are also very important in efficiently managing commercial contractual risks.

CHECKLIST PROCESS:

The routine use of good checklists for the review, creation, and modification of agreements is critical. Checklists help you to consistency consider all the relevant issues. Good document review and drafting checklists offer the benefits of insuring consistent quality, providing a sense of completeness, and concurrently being a training tool for others. A good checklist is also quite a time saver in reviewing and drafting documents. Checklists must be continually updated and enhanced. The proper use a checklists can be vital in contractual risk management.

BEST PRACTICES PROCESS:

Also, the on-going use of contracts management "best practices" such as contract summaries, contract presentations, correspondence management, change management, quality management, managing deliverables, service level agreement management (See: http://www.ncmahq.org/files/PDFs/CM_Apr08_p64.pdf), schedule management, subcontract/vendor management, intellectual property management (See: http://www.ncmahq.org/files/Articles/CM_Jan08_p58.pdf), confidentiality management (See: http://www.ncmahq.org/files/Articles/F5BC2_CM1106_-_C05_Back-To-Basics.pdf), insurance compliance, issue and risk management, dispute management, contract close-out, contract assessments, and lessons-learned activities are all extremely important in managing contractual risk in a professional manner and pro-actively mitigating commercial contractual risk matters.

SCORECARD PROCESS:

Additionally, the use of risk status scorecards from the initial contract review/negotiation stage through the contract performance completion/expiration/close-out stage (using red high risk, yellow moderate risk, and green low risk status determinations) really helps to keep the focus on contractual risk management. Scorecards quickly inform management of the risk levels of the applicable agreements. If you can measure it, you can manage it. The effective use of contractual risk management scorecards can go a long way in reducing and communicating contractual risks.

OTHER PROCESSES:

In addition to the checklist, best practices, and scorecard processes, the following other contractual risk management processes can be applied: (1) establish a contractual risk management team to meet regularly and manage contractual risks; (2) designate specific "owners" on the contractual risk management team to manage each specific contractual risk; (3) establish early warning signs (triggers) for each contractual risk; (4) develop and implement up-front preventive actions once the trigger becomes evident for a contractual risk; (5) develop and implement a post-contingency plan for each contractual risk in the event the contractual risk is not cured with preventative actions; (6) establish a contractual risk management register specifically describing each contractual risk, risk probability, risk impact, risk detectability, triggers, preventive actions, and contingency plans; and (7) conduct a debriefing that assesses the contractual risk matter and summarizes the lessons learned.

THE IMPORTANCE OF COMMERCIAL CONTRACTUAL RISK MANAGEMENT TRAINING:

Educate staff on the fundamentals of commercial contractual risk management. They need to understand the purposes and benefits of contractual risk management. Such training can address loss analysis from the past, reducing future potential losses, and identifying contractual risk management successes.

INSURANCE CAN BE PART OF YOUR CONTRACTUAL RISK MANAGEMENT SOLUTION:

Discuss with your insurance broker or your insurance companies the insurance strategies necessary to reduce commercial contractual risks (See: http://www.ncmahq.org/files/Articles/CM0509%20-%2048-55.pdf). Insurance, in itself, is not contractual risk management. However, insurance can be a valuable risk-financing tool.

OFFSHORE OUTSOURCING SOME ASPECTS OF CONTRACTUAL RISK MANAGEMENT:

One option to consider is to offshore outsource (i.e. India) some aspects of the contractual risk management process such as preliminary document review and initial contract drafting (See: http://www.ncmahq.org/files/Articles/CM0409%20-%2068-73.pdf). If done correctly, this can be a very cost efficient and thorough way to enhance the contractual risk management process.

FUTURE OF COMMERCIAL CONTRACTUAL RISK MANAGEMENT:

Commercial contractual risk management is necessary for success now as well as in the future. Ongoing successful company revenues, profits, and reputations can be wiped out quickly by ignoring or not discovering contractual risk threats. Conversely, if an entity is protected from contractual risks and threats, it can effectively concentrate and focus on its business without distraction. In the future, contractual risk management will increasingly play a more vital role in an entity's success. In an increasingly volatile and uncertain marketplace, the high-performing entities will require good contractual risk management.

CONCLUSION:

Every commercial domestic or international contractual risk management review, analysis, evaluation, and management activity has some unique aspects that may not be addressed in this article. However, if you routinely use this article as one of several resources when you perform commercial contractual risk management activities, you will be pleasantly surprised with the large number of substantive, material, risk reduction, performance improvement, and cost-savings issues and ideas that will be surfaced for proper evaluation.

Just remember Ben Franklin's advice ... "an ounce of prevention is worth a pound of cure."

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