Contract Management

Contract Risk Management: 10 Potential Risks and How to Avoid Them

Contract risk management is about mitigating risks associated with developing, drafting, and implementing a contract. Learn how to avoid risks here.

Every contract goes through multiple stages before it’s ready to be signed and placed into effect. This contract lifecycle requires a legal framework, discussions between the parties entering into the agreement, finalization, careful final edits, and approvals.

Once these stages are complete, the parties can move forward to implement the terms of their agreement for the duration of the contract. But often, there are issues with a contract that are overlooked. As you can imagine, this can be pretty problematic for all parties involved.

Unrecognized errors, ambiguous wording, lack of legal frameworks, or terms that are simply absent from an agreement can lead to disputes, legal trouble, or even unintended regulatory violations.

Luckily, there’s a strategy organizations can use to help protect themselves from these issues: contract risk management. Contract risk management is used to help recognize issues while they can be corrected.

Below, we’ll look at 10 contract management challenges and practical solutions to help manage them.

10 Potential Risks in Contract Management

Through every stage of the contract lifecycle, there are opportunities to make sure every condition is mentioned and all parties understand their legal and business obligations. An important aspect of each stage is recognizing contract risks and resolving them.

So, what is contract risk management?

Contract risk management is about planning for potential challenges with foresight and intentional wording to address them.

Risk management involves assessing what problems could arise in the activities outlined in a contract, each party’s roles and responsibilities, legal requirements, safety regulations, and other expectations. The next step is addressing each of these potential problems with conditions for managing and mitigating the risks associated. Risks can lead to legal battles, broken regulations, and breaches of contract, and reputational damage — all of which should be avoided at all costs.

Risk management is about reducing these risks in every conceivable way. Here are just a few different types of risk to look out for.

Risk 1: Ambiguity and Uncertainty

Every expectation and obligation detailed in a contract must be clear for parties to abide by them. This is true in practical terms, but also legal terms. The following business relationship is more likely to operate as expected when every objective of an agreement is direct, specific, and detailed. This is not the time for nebulous language or presumptions.

Harvard Business Review advocates for businesses entering a contract agreement to co-create a shared vision and objectives: “To keep expectations aligned in a complex and changing environment, both parties — not just the one with greater power — need to explain their vision and goals for the relationship.”

Ambiguity of important terms and conditions can lead to one or both parties unintentionally failing to meet their obligations, forming unnecessary discontent.

Risk 2: Miscommunication and Misunderstanding

If all parties aren’t properly notified of updates, requests, or changes made to a contract during negotiations and drafting, it can cause lengthy delays and confusion or lead to terms some parties can’t fulfill.

Even when legal has taken the time to carefully draft accurate details, if all parties don’t fully understand the terminology used, there can be contract terms that participants simply don’t comprehend. Most of us don’t speak legalese.

This miscommunication can lead to broader contractual issues when critical individuals or department heads are unintentionally excluded from the discussion.

Risk 3: Incomplete or Inaccurate Information

If a contract isn’t thorough, it can lead to speculation that risks business relationships and processes. Even a clear, legally-binding contract can leave out vital details. This is one of the reasons why using contract templates is a best practice.

Risk 4: Inadequate or Inappropriate Contract Terms and Conditions

Contracts are deliberate roadmaps of terms and conditions all parties agree to follow. Not only does this require legally-binding language, but the contract's language needs to be direct and relevant to each party's expected duties and abilities.

If inaccurate terminology is used to define contract conditions, or if there’s any room for misinterpreting expectations, it can lead to unintended breaches of contract that directly impact business — because whatever is written  in the contract is basically law.

Risk 5: Inconsistencies with Law and Regulations

Speaking of law, it’s incredibly important to keep legal parameters in mind. Contracts must clearly address the expectations for the organizations involved, and all entities must comply with legal and regulatory requirements. These need to be stated in the contract, so every party knows these expectations and requirements.

Especially in today’s complex technological landscape, a breach of contract could unwittingly violate:

  • Data security or privacy standards

  • Working conditions

  • Record keeping

  • Intellectual property (IP)

  • Disclosure requirements

Failing to include important regulatory data can result in legal disputes that drain resources for months or years. In some cases, it’s a misstep that an organization is unable to financially recover from.

Risk 6: Financial Risks and Liabilities

When mitigating risk, you must make it a priority to protect all parties from:

  • A party defaulting on their contractual obligations

  • A counterparty defaulting on their debts owed

  • Failure to pay for goods or services

  • Missing priority dates and deadlines for services or delivering supplies

Your contracts aren’t just official guidelines and expectations — they’re also your safety net for when things go south.

Risk 7: Intellectual Property Risks

The specific terms of an agreement are the property of the parties involved. The contract exists to preserve the terms they agree to and protect that information from getting into the wrong hands.

Protecting the IP of organizations and the binding arrangements they make with one another is an essential factor in risk management for contracts.

Considering the thousands of IP legal cases each year, this risk should definitely be on your radar. In 2020 alone, U.S. courts awarded a staggering $4.67 billion in patent damages, with the average patent litigation process costing between $2-4 million.

Risk 8: Cybersecurity Risks

Cybersecurity risks aren’t just about a breach of privacy, where sensitive contractual data could be exposed or even used as ransomware. Cyberattacks can lead to destroyed or corrupted documents as well.

But cybersecurity risks aren’t just about deliberate attacks. Unsecured documents can expose personally identifiable information on individuals and companies mentioned in a contract or IP critical to an organization’s market value. For more on this topic, read our recent blog post, AI Trends to Watch For This Year, which explores how artificial intelligence is affecting the cybersecurity landscape.

Leaking confidential data isn’t always deliberate, but it is the responsibility of all parties to take part in best practices that protect everyone’s privacy and best interests.

Risk 9: Force Majeure Risks

Force majeure — a French term that literally translates to “greater force” — deals with conditions under which contractual parties can be relieved of their obligations to the terms of that contract. In broad terms, unforeseeable or unavoidable events can impact the good will of organizations bound to an agreement.

Examples of force majeure that should be included in a contract include:

  • Natural disasters like floods, fire, hurricanes, etc.

  • Events like those caused by the COVID-19 pandemic, including lockdowns, limited distribution, and health risks

  • The outbreak of war

  • Governmental issues

  • Failures in critical infrastructure

But in order to be protected against force majeure risks, the contract has to get pretty granular. Contracts need to include specific scenarios that would relieve parties from their obligations, so they are not legally responsible to carry out terms under conditions beyond their control. If the past few years have taught us anything, it’s that life is unpredictable. So when it comes to contract terms, it’s always “better safe than sorry.”

Risk 10: Inferior Technology Risks  

Using the latest technology is one of the most important tools for mitigating risk when managing contracts. Without adequate technology, it is easy to waste time, valuable resources, and money to negotiate, draft, and produce documents. Limited technological resources can directly cause:

  • A dramatic loss of efficiency

  • Poor analysis

  • Lack of connectivity

  • Inadequate data sharing

  • Substandard compliance and tracking

Ensure your organization stays abreast of the latest and greatest tech so you don’t find yourself in this position. Subscribing to certain newsletters, attending conferences, and general networking are some ways of making sure you don’t fall technologically behind the times.

How to Avoid Contract Risks

CLM platforms help you identify important factors in drafting contracts that otherwise could take a long time at great expense. You can avoid many risks associated with contract lifecycle management using templates, automated processes, and alerts.

The following are 10 specific ways to help you manage risk.

  1. Conduct a Thorough Contract Review and Analysis

    You want to be certain the final conditions of your contract reflect the best business operations between your organization and other parties. Conducting a thorough review and analysis is a vital step for you to closely examine the most critical clauses of your contract. So, before everyone is ready to sign on the dotted line:

    • Make sure all of the contract’s legal terminology is clearly detailed, and all parties understand what they are agreeing to

    • Review the conditions that would lead to terminating the contract

    • Make sure the terms for renewing the contract are in order

    • Check every major milestone and make sure they are accurate

    • Be sure any remedies to changes or contract breaches are all included

  2. Conduct a Risk Assessment and Mitigation Plan

    Unfortunately, every contract will come with its associated risks. The way to best manage risk is to be aware of it and plan how to manage issues as they arise. This means using the feature set of your CLM platform to:

    • Identify potential risks and classify the risk types you find

    • Continue, over the contract’s lifecycle, to evaluate how business operations have aligned with the contract terms and look for any changes that could present risks

    • Evaluate the risks you find to determine their potential consequences

    • Estimate the probability that risks will occur

    • Establish what can be done to limit risk exposure

    • Develop contingency plans to manage these potential risks

    Like with most scenarios in life, it’s better to have a plan and not need it than need a plan and not have it. And in the case of risk management, you’ll never regret being extra prepared.

  3. Define the Scope of the Contract

    Every contract needs to clearly outline the document's purpose and what expectations the terms are placing on the parties entering into the agreement.

    Without clear definitions, it is possible for individuals or counsel to make false assumptions about their obligations. If those terms aren’t defined, the intent of the contract may not hold up later in court. It calls for detailing the entire scope of a contract and all parties fully understanding the terms.

  4. Use Clear and Unambiguous Language

    Legal terms are necessary for holding people to their responsibilities, but it is just as important that everyone involved understands exactly what those terms mean. The average person is confused and/or overwhelmed by legal jargon (in some ways, it’s essentially a foreign tongue), so using language that’s accessible is crucial for both parties’ success.

    It is important to provide documentation, including comments and discussions that take place throughout the contract lifecycle, so every party knows the meaning of every term.

  5. Ensure All Parties Understand the Terms and Conditions

    The goal of any contractual process is to bring all parties involved into understanding and agreement.

    Although you can’t literally sit around a campfire and sing kumbaya, using modern contract lifecycle management (CLM) software platforms can help teams gain clarity about every term and condition of their contract agreements. Templates, drafting tools, editing features, and data for compliance can bring information and communication into a single workspace.

  6. Establish Effective Communication Channels

    Like any relationship in life, communication is key. A modern CLM platform is designed not only to bring every element of contracts into a more efficient environment, but also to make it easier for all parties to discuss the details of a contract. By facilitating direct communication in a secure application, interaction happens faster than traditional methods while keeping sensitive discussions private.

    Making the best use of the resources helps ensure all parties are in unified communications and receive current updates throughout every stage of contract management.

  7. Ensure Compliance with Laws and Regulations

    CLM platforms can help you follow the proper compliance laws directly impacting your contractual agreements. Using accurate templates, sharing a dynamic repository for all parties, and establishing an ongoing workflow, a centralized application can help make sure your contract is up-to-date with current regulatory requirements.

    Legal departments can track contract data, pay close attention to any changes in compliance over the duration of a contract lifecycle, and take part in audits to validate compliance.

  8. Establish an Effective Dispute Resolution Process

    Within your contract, there should be clear terms and procedures that make it easy for all parties to understand the process for resolving disputes.

    Despite good intentions, agreeing to contract terms doesn’t mean that carrying out those agreements always goes smoothly. Having an established process for everyone to follow outlined in detail helps direct everyone toward conflict resolution and makes it clear what someone should expect if they willingly ignore the path that is established.

  9. Automate Notifications

    With a centralized CLM application, creating notifications for important details in your shared contracts is easy.

    Set alerts for changes in the cost of goods, updates from suppliers, renewal dates, and any specific milestones that might need your attention.

  10. Review and Update Contracts Regularly

    CLM applications help facilitate every phase of drafting a final contract all parties agree upon. Additionally, it allows these parties to connect the terms of the contract to resulting practices throughout the entire life of a contract.

    Conditions could change with suppliers, market prices, supply chains, and numerous other factors. In some cases, parties should review their contract terms to see that everyone is complying with expectations, and to refer to the contract terms for direction in managing uncommon external forces beyond organizational control.

    If the contract allows teams to make changes to the original terms, all parties can choose to revisit those terms.

Why Terzo?

Terzo provides you with the tools required to plan for these potential contractual risks and arms you with the right tools to address them, plan for resolutions and clear language, and make certain every connected party is alerted to the most updated details of a contract.

Terzo’s CLM platform provides robust alerts, task management, and the ability to connect the terms of your contracts to your company metrics to track the real-world results of your agreements.

If you’re ready to learn how Terzo can help you optimize your contracts and prevent potential risks before they arise, check out our free trial and get in touch with us right away.

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