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How do businesses manage contract risk?

Article

6 mins read

Updated on 24 April 2023

Our subject expert
Sarah Gunton

Quality and Compliance Director & Commercial Partner

Understanding contract risk is essential for any business looking to protect its interests and operate confidently. As part of a wider risk management strategy, assessing and managing contract risk can help prevent disputes, avoid losses, and ensure long-term commercial stability.

Whether you're a scaling start-up or an established player, working closely with our commercial contract lawyers can give you the clarity and structure needed to navigate every stage of the contracting process with foresight. From identifying your risk profile to building effective contract processes, this guide outlines how to take practical steps that put you in control.

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

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?

Training

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.

Processes

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.

Standardisation

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.

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.

Learn more

Pre-Contract

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!

Delivery team

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.

Lessons learned

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.

Make contract risk management a business strength

Being proactive about contract risk isn't just about avoiding pitfalls; it’s about giving your business a stronger foundation for growth. With the right approach, you can shift risk appropriately, streamline negotiations and ensure consistency across your contracting process. If you want to tighten your legal framework or develop more innovative ways to manage commercial risk, our commercial contract lawyers can support you with tailored advice and hands-on legal expertise that keeps pace with your business.

About our expert

Sarah Gunton

Quality and Compliance Director & Commercial Partner

Sarah is a commercial solicitor with more than 30 years’ experience helping businesses negotiate contracts, manage commercial risk and reach practical agreements.

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