"It's difficult to be part of any business and not hear about "risk." It's everywhere. Risk is the new black. It's on the lips of every CEO, CFO, and board member, as it should be. And, anything that is important to the board and the C-Suite is important to the legal department."
~ Sterling Miller, CEO and GC at Hilgers Graben PLLC
Ten Things: Spotting Analyzing and Managing Risk
Companies can face severe consequences due to non-compliance, lack of clarity, or something as basic as wayward punctuation—as was in the case of Oakhurst Dairy, which lost $5m due to a missing comma!
This is why successful legal counsels take contract risk assessment extremely seriously, as it ensures that every potential loophole is discovered and eliminated.
But how do you stay efficient with contract risk assessment, especially when managing contracts in high volumes? This is where a contract risk assessment checklist comes to the rescue! This guide explores how to build a solid checklist that keeps you on top of your game with risk management.
What is contract risk assessment?
Contract risk assessment is the process of identifying and evaluating potential risks associated with entering into a contractual agreement with another party.
The goal is to help organizations make informed decisions on whether to get into a business contract and, if so, what measures should be taken in the contract to minimize risk.
A thorough contract risk assessment typically involves reviewing the conditions of the contract, identifying potential risks associated with the business, assessing the likelihood and potential impact of each risk, and developing strategies to mitigate or manage them.
“To me, a risk only matters if it's material. If it’s immaterial, I don’t care about it.
To be material, it has to meet two conditions: It has to be likely to occur, [and] it has to be costly.”
~ Jonathan Franz, Head of Legal at Crunchbase
The Counsel Corner: Navigating Economic Turbulence and Thriving in Chaos
Some common types of risks legal counsels typically assess include:
Other types of risks may also be considered depending on who's involved and the nature of the contract.
Overall, contract risk assessment is an important tool for managing risk, ensuring that parties can enter into contracts more confidently and reducing the likelihood of disputes or other negative outcomes.
"You will not spot every risk your company faces, and that's okay. But you need to have a plan in place to catch the most important ones."
Sterling Miller, CEO and GC at Hilgers Graben PLLC
Ten Things: Spotting, Analyzing, and Managing Contract Risks
What is a contract risk assessment checklist?
A contract risk assessment checklist is a list of crucial tasks contract managers need to complete to successfully identify and evaluate risks in contractual agreements.
With a contract assessment checklist, you do not need to worry about remembering important points. All you need to do is follow a predefined guideline. This helps you identify problems beforehand and act proactively.
Contract risk assessment checklist: 10 steps to safety
You can build a contract risk assessment template based on historical contract risk analyses and work through it for future contracts.
Below, we'll explore some of the crucial things you must do to ensure you're on top of your contract risk management game.
#1 Evaluate the scope of the contract
This involves defining your obligations as stipulated in the contract, determining the deadlines for delivering on these obligations, and reviewing the cost requirements.
You'll also need to ensure that the stipulated obligations are specific and that all "gray areas" are clarified.
#2 Examine the delivery schedule
Here, you’ll dive deeper into deadlines and how they can impact both contracting parties. Are the deadlines too tight? Can your organization deliver within the said time frame? What are the risks associated with delivering behind schedule? Etc.
Managing deadlines is a core function in contract risk management. You can streamline this by setting notifications and reminders using a Contract Lifecycle Management (CLM) tool like SpotDraft. With SpotDraft, you'll stay updated with critical aspects of your contract lifecycle, including renewals, approvals, and terminations, among others.
Also read: How to set Contract Reminders for Free
#3 Evaluate the terms
This stage involves diving into the details of the contract terms, including pricing and payment, liabilities, warranties, and dispute resolution procedures.
Your goal is to ensure that the contract terms are fair for everyone. You don't want to overpay or get underpaid for anything. This stage usually involves a lot of negotiations. But a CLM can cut down the negotiation cycle by using automated approvals.
You can easily set triggers to automatically approve contracts with specific attributes, like pricing and payment terms, deal size, duration, and more.
#4 Review risks associated with location-specific obligations
If your contract partner operates from a different region—EU, US, UAE, etc.—you must evaluate all applicable risks associated with doing business in their areas.
The EU, for instance, regulates privacy through the GDPR, while the United States uses HIPAA, FISMA, GLBA, etc. Each has very specific rules you must adhere to and risks you must note.
It is important to evaluate these risks and how they impact product quality, exchange rates, mode of operations, and more.
#5 Research your contract partner
Doing business with a new partner comes with inherent risks. You want to avoid getting linked to a business partner that has an undesirable track record.
Research the organization's reputation, policies, mode of operation, and financial performance, and analyze how these could impact the entire contract experience.
#6 Dive into your mandatory provisions
Every organization maintains a library containing a list of clauses that must be present in all contracts. This can include nondisclosure, limited liability, payment terms, indemnification, force majeure, etc.
Every organization is unique. Thus, your mandatory provisions may be different from others. Regardless, you need to ensure that these clauses are present in all new contracts as they're structured to protect your organization's interests.
You can leverage a CLM to create a secure and accessible clause library you can easily import anytime.
#7 Review optional provisions
Optional provisions may be included alongside mandatory provisions to give your organization extra protection and advantage. Evaluate how these optional clauses can help mitigate risks associated with the contract and how excluding them may also impact the risk levels.
Again, you can use a CLM to import these into your contracts with just a few clicks.
#8 Identify high-risk clauses
High-risk clauses come with significant repercussions if breached. It is crucial that you carefully scour the contract to single them out. Evaluate the fairness of these clauses and renegotiate if necessary.
For instance, an indemnification clause can pose a high risk for the party providing the indemnity as it requires them to cover losses and damages incurred by the other party. It is important to evaluate such clauses and ensure they're not too broad or vague.
#9 Consider general regulatory standards
Identify all organizational, industrial, and federal standards applicable to your contract. Highlight all the risks and penalties associated with breaching any of these regulations.
It is also crucial to establish ways of proving compliance if need be. One way to do this is to ensure a complete history of all contractual activities is recorded to serve as an audit trail. This can be fully automated using a CLM. That way, you know you can quickly dive in and find proof, even during disputes.
#10 Track, track, track
Contract risk assessment is a marathon, not a sprint. You have to consistently monitor changes across each phase, as every new activity can open up a new level of risk.
Contract tracking with an all-in-one CLM is extremely easy, with tools for redlining, version control, notifications, and more. That way, you'll remain proactive and never be caught unawares.
Free contract risk assessment checklist template
Below we’ve included a free contract risk assessment template that outlines common risks, likelihood, impact, and sample mitigation strategies.
Feel free to modify it to suit your needs!
Please note that this is not an exhaustive contract risk assessment template. Certain risks applicable to your business may not have been covered here. Remember to adapt and customize the risks and mitigation strategies to your specific circumstances and industry.
Contract errors that proved costly for large companies
There has been a ton of real-life scenarios where seemingly negligible contract errors turned out to be costly for companies. Let’s look at a few.
#1 Inconsistent measuring units
In 1999, NASA's Mars Climate Orbiter spacecraft was destroyed during its approach to the Martian orbit because of inconsistent measuring units used between NASA's Jet Propulsion Laboratory (JPL) and its contractor, Lockheed Martin.
The navigation team at JPL had specified calculations in metric units within its contract. Nonetheless, Lockheed Martin’s team didn’t catch this. Thus, they used English units, leading to incorrect trajectory calculations and the spacecraft's ultimate destruction in the Martian atmosphere. NASA reportedly lost $327.6 million due to this error.
The incident was a major embarrassment for NASA, leading to a review of its management processes and communication with contractors.
#2 Lack of clarity in contracts
In 2010, the Deepwater Horizon oil rig operated by BP exploded, causing one of the largest oil spills in history. The spill resulted in billions of dollars in damages, cleanup costs, and numerous lawsuits.
One issue that came to light during the aftermath of the spill was that BP had signed a contract with Transocean, the owner of the oil rig, without noticing a clause that allowed Transocean to avoid liability for any spills that occurred.
This contract led to a lengthy legal battle over who was ultimately responsible for the damages.
#3 Punctuation error
Oakhurst Dairy, a Portland-based dairy company, was in court in 2018 after three of its lorry drivers claimed they had not been paid over four years of overtime wages, as required by Maine’s overtime law.
The overtime wage law states that employers are responsible for paying overtime wages for “the canning, processing, preserving, freezing, drying, marketing, storing, packing for shipment or distribution of produce, meat and fish products, and perishable foods.” A tad confusing to read, anybody would’ve simply skimmed through it—but not these drivers!
The lorry drivers argued that because there was no Oxford comma between shipment and distribution, it meant that distribution was a component of the packing process and must be paid for.
Interestingly, the court ruled in favor of the lorry drivers, making Oakhurst Dairy pay them $5 million in compensation.
Stay one step ahead with an all-in-one CLM tool
In-house legal counsels are in a never-ending battle with contract risks, as ignoring or missing these can pose significant risks. It gets overwhelming when contract volumes scale, taking the volume of repetitive contract risk assessment processes along.
This is what makes an all-in-one CLM like SpotDraft indispensable. It comes fitted with a wide variety of tools you can leverage to keep your contracts secure, monitor changes, and manage risks more proactively.
Want to see it in action? Request a personalized demo.