A critical part of any business is contract management: assessing and mitigating the risks associated with the contracts entered into by the business.
In our earlier article on knowing you risk profile; we outlined both the benefits of understanding your contractual risk profile and also the key types of contractual risk.
Armed with that knowledge, how do you manage and mitigate these risks?
Entering into contracts is a process and you can take steps at every stage of this process to mitigate risk. Our commercial lawyers can support you in doing this.
Set yourself up for success
It is possible and advisable to identify and understand your contractual risks at an early stage in the life of your business.
Knowledge of the risks takes you a long way towards mitigating those risks. These risks will be different, depending on the type of business that you run, where you carry out your business and the industry or market in which you operate. For example, a highly regulated marketplace will require you to comply with specific requirements in order to secure and fulfil contracts.
Typical questions are as follows:
- What are the key risks that you face in entering into contracts?
- Is it payment default?
- Is it over-reliance on your suppliers?
- Are your goods perishable?
- What typical contractual obligations in your industry will be difficult for you to meet and how will you deal with that?
Once you know the key risks, you can train your team on how you, as a business, will approach those risks. This may be through adopting contracting processes and standard terms of doing business which transfer those risks to the other contractual party, on the basis that it is in a better position to manage those risks. Training can also highlight who within your business is responsible for doing what in the contracting process.
Knowledge of your key contractual risks also allows you to put in place:
- appropriate contract management processes, for example, use of appropriate management software. We dig deeper into these processes in our article on contract lifecycle management
- processes to ensure data privacy and to reduce the risk of a data breach; and
- insurance for those risks that cannot be transferred or otherwise mitigated.
Our legal team can assist you in providing relevant training and establishing contract management processes.
Understanding your key risks helps you create standard contracts or terms and conditions that you can use with all (or at least the majority) of your customers and suppliers. You can also decide which contractual terms you're prepared to ‘flex’ in order to get the deal done and which are non-negotiable.
The importance of having standard terms and conditions in reducing contractual risks cannot be over emphasised. Their benefits include:
- ensuring that your contracts are drafted in clear language and therefore are not subject to dispute over interpretation if a problem arises;
- standardising your approach in relation to key issues;
- speedy contracting, providing that terms are relatively fair to both parties;
- providing protections against financial risk such as title retention clauses and requirements for deposits and security;
- giving clarity to your insurers as to the risks that you are asking them to cover; and
- legally shifting contract risk from one party to the party in the best position to control or prevent losses or damages. There are different ways to transfer contract risk, including:
- indemnities: these compensate a party for losses caused by the other party’s action or inaction.
- limitations of liability: this caps the amount of damages the other party can claim from you in various scenarios.
Find more details on this in our article on contract risk transfer and limiting the liability of your business.
It is common practice to refer to your standard terms of business (often by way of URL) in the order documentation. The documentation then focuses on contract variables such as order volume, timescale, milestones and specification (which tend to be the details that you and your team find interesting and which inform your obligations). By doing this, your responsibilities are more visible to you because they aren't hidden by information that's better explained in your standard terms and conditions.
You can learn more in our guide for putting in place standard terms and condition of business.
Commercial legal advice
Assessing and managing your contractual risks can make a big difference not only to the ease in which you do business but also to your bottom line and, ultimately, the survival and success of your business. Our commercial solicitors can support you in assessing and managing these risks.
Once you have your standard contractual terms and your contract management process in place, there is a process of discovery before any specific contract negotiation.
External due diligence
Before you invest your time in contract negotiations with a new customer or supplier, it is important to carry out some due diligence, including into:
- the other party: including financial reputation, track record, experience, contracting reputation in general;
- location: where will you be doing business and what does this mean for you? For example, will there be additional administrative requirements as a result of delivering outside the UK, for example transporting people and/or equipment, or gaining access? What does this mean for your (or the other party’s) ability to perform the contract?
- industry: is it an industry in which there are additional regulatory requirements?
- red flags: are there any issues that strike you as difficult or potentially onerous in addition to those mentioned above?
Internal due diligence
In addition to carrying out external due diligence, it is equally important to undergo some internal due diligence - especially as a start up where you might have limited resources. Do you have the capacity and resources to carry out the work?
During contract negotiations
Contract negotiations depend very much on the type of business that you operate and the stage it is at in its lifecycle. For a start up, it is very tempting to take contracts on whatever terms are available – but these might destroy your business later down the line.
Contract negotiations will focus on:
- discussions about whose standard terms should apply to the contract.
- potential deviations from your standard terms and conditions and what these deviations mean for your risk profile and insurance;
- population of any variables, such as delivery dates, milestones, locations - and what these mean for your pricing and payment terms;
In the event that you have to trade on the other party’s terms of business, you should focus on what this means for your risk profile and your insurance.
Post contract negotiations
Once you have signed the contract, you or the other party or both must perform!
It is critical that your delivery team knows the terms of the contract, especially the key terms around dates, volumes and specifications.
This requires good communication within your organisation which should be reflected in your contract management process.
Ongoing contract management
Ongoing contract management is necessary both to ensure that suppliers perform for you and that you perform for your customers.
Contract management will also ensure that you do not miss key renewal or termination dates.
Ongoing due diligence
Ongoing due diligence into the other party should be undertaken to highlight changes in credit rating and similar so that changing financial and security risks and risks of non-payment or non-performance can be assessed.
Early knowledge allows you to take early and proactive action.
As you and your team perform under your contracts, you will discover which elements of performance are difficult for you. This knowledge should be communicated back to the business development and sales teams so that appropriate adjustments are made to your contracting strategy, process and standard terms.