Top 4 contracts risks and how to avoid them
Many organisations typically deal with hundreds of contracts a day: from the single paragraph that covers the charity chocolates in the tearoom to tomes drafted by lawyers with contingencies, milestones, deadlines, conditions precedent and subsequent, limits and rules, deliverables and receivables. And while all contracts carry some element of risk, but some contracts are riskier than others.
Is your organisation prepared for the worst-case scenario – or even the likely scenario – of the most common contract risks?
Risk 1: A condition precedent isn’t met, or a sunset clause passes without action
Best-case scenario: It is a relatively minor clause with nothing else reliant upon it. Everyone agrees to rectify it and carry on as if nothing happened.
Likely scenario: Time delays as everybody tries to figure out why the clause is there and what else is contingent upon it. An important component stops being delivered or a third-party contract lapses. Fingers start pointing to determine where the incompetence came from.
Worst-case scenario: It’s not hyperbole to say this can be a life-and-death situation when the clause in question relates to matters of safety. If work should not commence until OHS measures are in place, is your organisation ready to bear the consequences? Discovering an insurance policy has lapsed after an injury has happened on site could be the most costly mistake your organisation ever makes. But significant legal and financial consequences pale in comparison to being responsible for serious injury to your people.
How to avoid it: Your contract management system must have built-in checks and balances that are as close to foolproof as possible. Centralised date management tools must ensure key dates come to the attention of those who need to know them. Complex organisations should have multi-party contract management enabled.
A centralised contracts management system will require certain approvals before a contract can proceed through the system. Does your organisation have an insurance, securities, guarantees & escrow management function?
Pre-qualification tools can provide information about suppliers and whether they have the right credentials, certificates and background for the job. Risk assessment tools identify and track hazardous activities, determine possible consequences, then apply the appropriate treatment.
Risk 2: A missed deadline, milestone or deliverable. This is the most common failure of ad hoc systems – there is no centralised, systematic trigger to alert those who need to know that a key date is approaching
Best-case scenario: The deadline is one that has no knock-on effects and the delay is minor.
Likely scenario: Retrospective remedial action is taken by the party at fault to remedy the breach. People’s time is wasted and somebody has to go through and check that there is no impact on other clauses or projects. The party in breach is likely to have a penalty clause applied and relationships may sour.
Worst-case scenario: Companies go bankrupt over missed deadlines. If other projects are contingent on successful completion of milestones or deliverables, a domino effect could cause those deals to fall over. Expensive litigation could cause an organisation to face financial and reputational ruin.
How to avoid it: Ensure you have a centralised date management tool to manage key dates. The system should provide for email alerts to go to all major decision-makers, so you never miss a deadline, delivery or decision point.
Risk 3: The contract contains an automatic rollover clause. This is often a “forgotten” risk of contract management
Best-case scenario: The contract was one you would have renewed anyway on exactly the same terms.
Likely scenario: Loss of bargaining power: you lose the opportunity to terminate, re-tender or negotiate changes.
Worst-case scenario: You are stuck with services you no longer need or that no longer suit your purposes for another term. There is costly litigation to extract your company from an unwanted contract. Your organisation faces penalties for breach. You are non-compliant with competitive tendering requirements. You face accusations of incompetence or even corruption.
How to avoid it: Again, a fundamental tool in your contract management toolbox is centralised date management, alerting contract managers to key dates in plenty of time to enable informed decision-making.
Risk 4: Inconsistent treatment of contracts, or ad hoc document management systems. This may occur within the organisation, where contracts are treated inconsistently at different times or for different projects
Best-case scenario: those who hold the necessary knowledge never retire or have holidays and are pro-active about sharing information. They have a meticulous filing system that everyone understands and can run with in case they are hit by a bus.
Likely scenario: Documents become misfiled, systems are chaotic and people leave the company without a clear succession plan for knowledge sharing. Audits become onerous as records are too numerous to manage. There is deterioration in relationships where there is no common understanding between you and your supplier.
Worst-case scenario: Budget blowouts due to unchecked scope creep. Suppliers no longer want to work with you because of frustrating delays. Perceived incompetence of the organisation as a whole. Litigation when conditions aren’t met or contracts fail.
How to avoid it: Your system should have a single data-entry input, which will improve consistency and efficiency. Direct supplier inputs will build process integrity, compliance, probity and risk management. Make sure you have post-contract document management that is keyword-searchable.
Managing and mitigating contract risk – in all its forms – is a central tenet for any organisation. A good contract management system is your most powerful tool for minimising those risks.
Ryan Newstead, Principal Consultant, Open Windows