What is a contract risk? 

Contract risks are adverse outcomes or issues that arise when businesses deviate from their agreed-upon contractual terms or lack a proper contract management process.

Contracts play a crucial role in building trustworthy business partnerships. Failing to manage contractual risk effectively can result in financial losses, damaged relationships, and legal disputes.

Contract risks exist in various forms and can occur for various reasons, including ambiguous contractual terms, unfulfilled obligations, financial instability, or non-compliance with laws and regulations.

 Common types of contract risks 

 What is contract risk management? 

Contract risk management is the process of identifying, evaluating, and mitigating potential risks associated with your contracts and contract management process.

A comprehensive approach to contract risk management includes: 

• Identifying and analyzing all potential risks.

• Developing effective risk mitigation strategies.

• Monitoring the implementation of those strategies.

Risk is inevitable, but creating a risk mitigation plan can help businesses:

• Protect business interests and reputation.

• Reduce operational disruptions. 

• Provide dispute resolution mechanisms to navigate complex situations.

• Minimize unanticipated risk. 

• Accomplish a specific task despite unforeseen events by having a Plan B in place.

Contract risk management: A five-step framework 

1. Identify potential risk-causing factors.  

The first step is to clearly chart out the steps and the parties involved in your CLM process, and identify potential risk-causing factors in each of these stages.

Questions that help with identifying risk-causing factors include:

1. Are my contracts stored securely?

2. Who has access to the contract repository?

3. Are the contract terms clear and unambiguous?

4. Is there a process to track and manage contractual obligations?

5. Are there reminders for key milestones, such as renewals or terminations?

6. Are my standard terms updated periodically to stay compliant with changes in regulations in my space?

7. Do I have an approval process set up for critical contract types?

How comprehensive your list of possible risk-causing factors is will determine how effective your risk management plan is.  

2. Assess contract risk impact. 

Understanding the potential impact of identified risks and prioritizing those risks allows you to develop a comprehensive risk mitigation plan.

Asking specific questions and considering key metrics help measure the severity of each risk and its implications.

• What are the potential financial consequences associated with each identified risk? How might these risks affect the project budget and profitability?

• What identified risks threaten project timelines, resource allocation, and overall operational efficiency?

• Are there any risk overlaps that could amplify their combined impact?

Check out our Contract Management Checklist for a more detailed assessment.

By systematically evaluating risk aspects, organizations can get a comprehensive understanding of the potential risks and implement risk mitigation strategies at every stage of the contract lifecycle.

3. Implement risk mitigation strategies.

At a contract level:

• Conduct extensive background research on counterparties to understand their objectives, standards, and limitations to mitigate the risks associated with partnerships.

• Evaluate contractual obligations and assess their feasibility, considering the potential challenges and costs needed to meet them. This prevents overpromising and facilitates effective negotiation.

• Review contract deadlines, delivery dates, and payment schedules to ensure alignment with operational capabilities, minimizing the risk of missed deadlines and associated penalties.

• Encourage contract authors to document any deviations from standard language for clarity and consistency.

At the contract management process level:

• Centralize contract storage to provide easy access to all contracts.

• Mandate contract approvals involving relevant stakeholders for critical contracts.

• Configure automated workflows for approvals and signatures to minimize delays and improve performance.

• Set reminders for contractual obligations and milestones to improve compliance and reduce risk.

• Implement modern CLM tools with end-to-end encryption to strengthen security and privacy.

• Streamline contracting processes with digital CLM software.

4. Establish a clear contract risk transfer. 

Contract risk transfer is a legal process in which one party transfers contract risks to another party who is better positioned to prevent losses or bear the potential financial consequences when they occur.

Strategizing contract risk transfer is crucial in the contract risk management process. Insurance contracts, indemnification agreements, lease agreements, and subcontractor or service agreements are common contract types involving risk transfers. These contracts contain clauses that explicitly outline the allocation of risks between parties.

5. Monitor and manage contract risks. 

Effective contract risk management requires continuous monitoring and mitigation throughout the contract lifecycle. It's crucial to periodically review, refine, and modify the contract management process based on the contract risk management framework. This helps prevent misses and enables proactive risk management.

 Contract risk management using contract management software 

Contract management software is a game-changer for legal teams. With their extensive capabilities, contract management software plays a major role in simplifying contract management and mitigating contract risks.