What is contract risk management and why should you take it into account?
Signing contracts to regulate the relationships that arise with suppliers and / or customers is something daily in many companies.
These documents that we call "contracts" are nothing more than putting the parties' wishes in writing and are mostly fulfilled, but some of them may be breached, or at least part of the terms and conditions established by them.
When that happens, the "contractual risk" that we will define below materializes and involves going to court to compensate the damages that have been caused.
What is "contractual risk"?
We can define it as the possibility of facing losses as a result of one of the parties not complying with the essential terms of a contract.
This breach usually translates mainly into two risks:
- Risk in the execution of the contract, that is, the possibility that one of the parties cannot carry out the terms and conditions and breaches its obligations.
- Financial or economic risk, that is, that one of the parties fails to comply with their financial obligations, such as the remuneration for the provision of a certain service, or, alternatively, that this non-compliance entails an economic expense to the non- performing party to repair the damage caused by the non-compliance of the other.
It should not be forgotten that in addition to the two risks mentioned above, there are other risks such as reputational risks, a bad relationship with third parties or a decrease in morale in the parties.
The "contract life cycle" matters, and a lot!
But what is the "contract life cycle"?
We understand as such the evolution of the contract, that is: the entire process from the identification of the need, through the contact and negotiation with the counterpart, when the execution of the contract occurs and, finally, the termination of the validity of the contract.
Risks change during the "contract life cycle" and it is necessary to adapt and consider the possible risks that may arise.
Let's give an example of some of the risks that may appear:
Imagine that two parties want to carry out a common project and want to put in writing how they will work together.
One of the parties searches the internet for a model contract and sends it to the other party.
Here we already have a risk!
It’s very likely that the model does not cover the particular needs of the parties or, well, that the legislation that is applied is outdated.
And what if you should have sent it to your attorney but didn't? Control of where the contract is will likely be lost.
Manual processes and the lack of automation can generate gaps in communication and, consequently, generate conflicts and risks in negotiations.
In the same way, the contract and signature cycles will slow down (likewise, an improper signing process where the wrong person signs can be another risk) and can result in a loss of a business opportunity.
We have structured the "contract life cycle" in 4 stages, each with some risks:
- Inadequate contract structure.
- No financial viability.
- Insufficient or non-creditable party credentials.
- Wrong legal framework.
- Information leakage, loss of confidentiality.
Poorly determined rewards.
Gap in intellectual property.
Limit of responsibilities.
Delay in payment of salaries.
Responsibility of the parties.
Termination of contract.
Claims for non-compliance.
So, let's see what happens and what risks we expose ourselves to:
At this stage, it is necessary to define what type of contract is adequate to regulate the relationship between the parties.
Although in the contractual sphere the the ruling principle is the principle of the "primacy of reality" / nomen iuris or what is the same:
"things are what they are and not what the parties say they are", it is necessary to choose the legal form well of the contract to avoid application problems.
Consequently, the structure of the contract is fundamental, understanding and, above all, understanding the contract will be of vital importance in order to comply with the terms and conditions.
Without forgetting the legal framework that will govern the future relationship, it is useless to apply a regulation if it does not suit us or we are not familiar with it, that will only cause problems.
At this stage, it is convenient to confirm if the other party has sufficient capacity to contract, if it is legitimized and has the necessary credentials or licenses to carry out its activity and if it has debts with third parties that could endanger the business of the parties.
Similarly, the issue of confidentiality takes on special importance, especially when strictu sensu nothing has still been regulated.
It is very convenient to sign a confidentiality agreement so that the information that is shared remains within the "business secret" and to avoid breaches and leakage of relevant data about the business of the parties.
This initial stage can be accelerated by using pre-drafted templates that will create legal documents more quickly, without a doubt technology and more specifically legal document automation software can save considerable time and money.
Now is the time to lay the foundations that will define the contract and incorporate it as a clause.
Concepts such as remuneration, objectives, intellectual property, guarantees, the limit of responsibilities and compensation appear.
These concepts can be a significant source of risk as they are essential terms of the contract. In order to speed up this process, it is highly recommended to individually negotiate each of the clauses and make sure that both parties understand their scope.
In the preliminary stage, work on a proposal should already be started, since in the negotiation stage there is a significant risk that relations will be broken and the formalisation of the contract will not occur if the parties do not align their interests.
This stage of negotiation requires time and effort. It can often happen that the situations under which the terms and conditions were being negotiated change.
It is extremely important to keep a detailed record of all the discussions that have taken place as well as the different versions of the document.
Having the support of a software or digital platform that allows us to effectively keep track of the different versions of the document will be very useful to review the changes and modifications that have been implemented.
Negotiated contract, signed contract and execution of the contract.
What does it mean that a contract is executed?
That it begins to unfold its effects and, therefore, the parties must comply with what is established in it.
It is time to provide services and pay the fees.
But also that there are contractual breaches, delays and responsibilities.
Each party must comply with its rights and obligations during the term of the contract, the performance.
In order to avoid performance risks, it is necessary to continuously monitor the effects of the contract. Inefficient management of a contract can result in forgetting renewal deadlines, expiration dates or failure to implement relevant modifications, which can lead to customer complaints or even the risk of reputational damage.
Furthermore, it should not be forgotten that for a contract to be effective, it must be signed by the right person, i.e. by the person who is qualified to sign it.
It happens, however, that sometimes it is complicated to coincide in time and form to carry out the act of signature.
What is the solution?
The digital signature.
By means of this technological solution it is possible to sign a document remotely and with full validity.
The contract comes to an end and it is time to terminate the contractual relationship.
Or renew the contract for another period (agreed by the parties).
What happens if the decision to terminate the contract is not communicated or if, on the contrary, it is the wish of the parties to extend the contract?
To avoid these risks, technology allows us to set up a warning system to alert us of events to be taken into account during the "contract life cycle".
There are some contracts that are more exposed to risks, so it is important to analyze some circumstances to implement the appropriate mechanisms to avoid them.
Thus, for example:
- the date of the contracts is an aspect to take into account, if the contract was signed a long time ago, it is highly probable that the particular circumstances of the parties have changed and may affect how the service is provided or , for example, the applicable regulations have ceased to be in force.
- The nature of the contract may affect the appearance of certain economic risks.
- The parties involved in the process, both in the negotiation process and in the provision of the service, for example, may generate a lower or higher risk.
- The data to which you have access on the occasion of the conclusion of the contract, it is very important to establish secure mechanisms to store and process the data that the parties can access.
- The regulation is changing and each geographical area has its own regulation.
Is there a formula to mitigate or eliminate "contractual risk"?
Not exactly, but there are some considerations or tips to keep in mind to reduce risks turning into damage.
1. Evaluation of the contract: in search of the “mandatory” provisions.
The first thing to do is to review the essential or "mandatory" clauses of the contract in order to verify:
- The scope of the contract, that is, what is the duration, what remunerations are there and how they will be paid, what responsibilities and the functions the parties have.
- Define the standard of care or what is the same: that the provision of services is carried out in accordance with the maximum possible diligence, in no case can results be guaranteed (especially in cases of provision of professional services);
- The limitation of liability in order to reduce liability in the event that certain circumstances occur.
- Establish compensation.
2. Proper legal advice can avoid unnecessary risks
It is vitally important that the contract is supported by the knowledge of a legal professional. It is useless to write a contract if it is not approved and endorsed by the knowledge of a lawyer.
This professional will ensure the adaptation of the contract to reality, proposing the most appropriate wording to safeguard interests, reducing the impact on eventual risks.
In the event that the risks in damages materialize, it will be in charge of promoting the measures it deems necessary to protect and ensure compliance with the terms and conditions of the contract, minimising the impact of contractual risks.
3. Technology, the best ally
Implementing a contractual automation process such as Bigle Legal is an ideal solution to significantly reduce risks in 'contract risk management'.
Because it allows you to efficiently execute some inherent risks of the contract that is manually formed and is difficult to manage. Let's see:
Effective monitoring of the "contract life cycle".
Let's take an example: two parties sign an agreement with a duration of 5 years, the contract specifies that if any of the parties wishes to extend or renew the contract, they must reliably notify the other party.
However, they forget to do so and the contract is de facto terminated, a priori they continue to provide their services but one of the parties breaches its obligations. What happens then?
The party that has suffered the breach claims and the party that has breached defends itself arguing that the contract is terminated.
Who is right?
This is just one example of how the sending of the communication could have been automated with the decision to continue with the contract or, at least, receive a notification or alert that the expiration date is close.
Efficiently managing milestones, renewal or expiration dates is one of the most risk-sensitive matters inherent to a contract and can be automated by sending notifications or notices to the right people.
Centralize document management.
Using a single space to store all legal documents allows you to efficiently classify and locate the contracts of each customer and/or supplier. Here you can easily find current active contracts, templates for creating new contracts as well as the history of contracts created (and signed).
No physical paper, eliminating the risk of misplacing a document by storing it in the cloud, understood as the storage of data outside our devices.
Efficiency in the search for terms.
With technology it is possible to run an indexed search function to find terms within a contract.
It is very efficient to use a keyword to find it in each of the clauses of the contract, in order to modify or delete the terms related to it.
Limit access to contracts.
By configuring access based on permissions and roles, you can limit who can read or edit documents or contracts.
This can prevent contracts from being read by unauthorized people and, likewise, being edited by them. In addition, with this system, we are guaranteeing and minimizing the risk of a security breach and confidential information being accessed.
Checking the latest version of the contract to review the new modifications is essential!
One risk that must be taken into account is regarding the validity of the regulations.
The regulatory environment is periodically changing and applying repealed or non-applicable regulations can create regulatory risk.
In the same way, the templates that are used by means of a contractual management software allow access to new, more precise and periodically revised ones.
As mentioned, version control and monitoring of compliance with terms and conditions is key to effective "contractual risk".
Legal technology software allows customised reporting on the performance of the parties and the status of the contract in a visual dashboard, through the automatic collection of all relevant data and its compilation.