If there is one thread you can follow through every organization and use to track the health and wellbeing of a company, it’s the contract lifecycle. A bad clause here or inarticulate phrase there can quickly expose the organization to a host of contractual risks.
Getting your contract right every time isn’t easy, but also not impossible if you use the right tools and techniques. It requires diligence, attention to detail, and a streamlined process using all the latest contract risk mitigation strategies.
With an effective contract risk mitigation strategy, you can navigate the uncharted waters of continuous disruption, innovation, and business agility.
Contract risk mitigation is the process of identifying, evaluating, and limiting the exposure to risks across your organization. It depends on a strategic assessment of all the potential hazards an organization may face during operations.
While you may not be able to manage or anticipate every risk, you can plan for different situations to help lessen their impact on the business. The same rule applies to any business agreement your company signs.
An effective contract lifecycle management (CLM) process puts risk mitigation at the forefront of every business agreement. Without an adequate risk mitigation strategy driving your contracting process, organizations can leak 9% of value according to analysts at KPMG and World Commerce and Contracting. Putting your CLM at the heart of your digital transformation allows you to identify, assess, and mitigate risks using a collaborative framework.
Tip: Rest easy knowing that contract lifecycle management (CLM) software is doing the heavy lifting for you and identifying risks.
Contract management is a discipline that affects every element of your business. It governs your employee agreements, partnerships, supplier performance, and almost every other facet of the company’s operations. Legal counsels, contract managers, and procurement teams understand the inherent risks in each business agreement but also know that managing the exposure effectively slows down the contracting process.
Managing risk effectively during each iteration of the contracting process requires an agile organization that can respond to changes effectively.
Dynamic risk management requires three key components:
To build a risk management framework that can respond to changes effectively, McKinsey & Company recommends taking five separate actions.
Source: McKinsey & Company
As contracts are one of the key containers for moving risks through the business, any change to your strategy should consider the following four contractual risk types during each phase of your CLM.
As modern businesses expand beyond traditional territories, the legal and regulatory compliance risks grow exponentially. These elements usually involve a breach of contract that carries the potential for legal accountability and litigation.
A breach of this type can include compliance failures with regulatory frameworks like:
The list above is not extensive, as every organization’s legal and regulatory risk exposure will depend on its operations and geographical footprint. For companies that conduct business in the European Union (EU), the new General Data Protection Regulation (GDPR) will also apply. The same is true for ventures that operate in Canada (PIPEDA) or states like California (CCPA).
The biggest risks here are infringing on personal privacy or failing to secure personally identifiable information. There are also additional risks like intellectual property (IP) theft, using the wrong language in clauses, uncontrolled disclosures of information, inadequate insurance or licensing practices, and general legal disputes.
Many of the acts listed above deal exclusively with data privacy but there are additional security risks to consider when evaluating your strategy. Any unwanted destruction of data, unauthorized access and dissemination of information, or breach of company systems can lead to a host of issues for the organization.
Because contracts contain much of this sensitive information, you should consider these as part of the inherent risks when optimizing your CLM. The risk of this information falling into the wrong hands is considerable when you think about the amount of correspondence and communication that takes place during the different contracting stages.
The risk increases exponentially if you use unsecured methods to communicate contractual information between parties. You can also expose yourself to security risks by inadequate training, ineffective data protection policies, or lax permissions and access controls.
Data breaches specifically pose a massive risk considering the steady increase in cybercrimes and the devastating effects it has on businesses. Attackers started targeting legal firms due to the treasure trove of information these entities store, manage, and retain for clients. Managing the security risks in your CLM process remains one of the biggest challenges for modern businesses.
Missed obligations, insufficient warranties, or claims problems expose the organization to financial risks. There are a myriad of scenarios where these situations creep into the contracting process if risk mitigation isn’t a priority for the organization. These include:
Financial losses can occur on the buyer (accounts payable) or seller (accounts receivable) side of operations. Mitigating these risks is part of a larger business strategy but can still affect individual agreements when you don’t have the proper controls in place. Common causes could include missing key dates from agreements (including evergreen clauses), compensation variations based on performance indicators, or unenforceable termination clauses due to incorrect legal language.
Every organization depends on a reputation that can take decades to establish. Brand risks include damage to reputation, recognition, and awareness that can affect employee morale, customer loyalty, and public perceptions.
Ensuring brand safety depends on limiting negative perceptions that can come from associations or failures to respond to an incident effectively.
Brand damage may occur when:
Brand damage and risk are difficult to quantify and mitigate without having specific clauses relating to the image and ethics of an organization as part of the agreement.
Although no organization can avoid all contractual risks, you must limit exposure to acceptable levels using a balanced strategy. When organizations fail to mitigate contractual risks, the effects can be catastrophic to your organization’s brand, financial, and operational health.
Reasons to implement contract risk mitigation include:
Contract management usually involves multiple stakeholders with competing interests. Each of these also relies on a variety of tools and technologies to manage operations. The contracting process needs to support all these interests while limiting risk exposure and ensuring an efficient CLM across the organization.
Along with digital transformation efforts, organizations should adopt a balanced approach to contract risk mitigation. You can do this by:
With a digital contract management solution, organizations can establish the required mitigation strategies to protect against operational, financial, and brand risks.
Tip: Want to take a deeper dive into how to identify, assess, and mitigate contract risk? Check out this free webinar.
Establishing a framework that consistently mitigates your risk exposure during the contracting process should form part of your governance, risk, and compliance (GRC) strategy. You can follow these steps to build an effective contract risk mitigation strategy.
The first step is to understand your current risk profile by identifying where each risk exists within your current agreements. You’ll want to review each contract for the risk types identified above and list these in your assessment.
You should also look at your current CLM process and determine where risks are entering the workflow to understand where you’ll need to establish additional controls.
Once you understand where risks exist, you need to evaluate each according to the anticipated consequences and the probability of occurring. This enables you to create a scorecard of your current risk exposure and prioritize where you’ll need to start your mitigation efforts. Wherever you cannot eliminate the risk, you’ll want to establish acceptable thresholds to ensure you can limit the exposure.
Armed with this information, you can start establishing the required controls and mitigation processes in your contracting model. This requires you to create a responsible, accountable, consulted, and informed (RACI) model for all stakeholders involved including a risk response plan with clear roles and designations.
You should then develop the necessary contingency plans for risks with higher exposure or propensity of occurring and inform your team about their roles and responsibilities when dealing with these incidents.
To make it easier on your teams, digitize your contracting process and establish a central (ideally encrypted) repository for all related documents and records. Your RACI model will help to identify the key roles required for your digital system, and you can set up your authentication, authorization, and access controls.
Keeping everyone up to date with your contractual obligations is easier using alerts and notifications that drive the contracting processes. To streamline your new contract requests and document intake tasks, use a standardized process for all communication and onboarding of third parties.
You can prevent scope creep by clearly defining all scope of work (SOW) early in the process. This will also eliminate the risk of disputes in the future and shorten the time it takes to complete the contract negotiation stage of the lifecycle.
Use clause and template libraries to streamline the drafting process with pre-approved legal language for all your terms, conditions, and types of contracts. You can leverage automation tools like a workflow engine to manage all your business rules like reviews, approvals, and clarifications.
Use version control to keep track of all changes and document comments and create a complete audit trail for each agreement. You can also use e-signatures to make it possible to approve contracts from anywhere, further helping to streamline the entire process.
If you have a digital process, you can start generating analytics about your CLM’s efficiency to inform future decisions. You can group contracts according to risks and see where any of your mitigating efforts didn’t provide the results you wanted. Use this information to constantly review and optimize your risk mitigation strategy accordingly.
Source: Contract Logix
Today’s business landscape is more complex than ever before. With factors like remote work, cross-border solutions, digitalization, and the service economy, mitigating contract risks is an essential part of managing a successful organization.
The tools and technologies available today make it possible to establish a robust framework for contract risk mitigation from a central location. You can deploy a cloud-enabled contract management system that’s entirely configurable according to your specific CLM model.
Contract management software can help you start leveraging all your contract information and speed up your digital transformation efforts.
As more organizations are looking to digital technologies for gaining the competitive edge, deciding where the biggest value potential is may be a challenge. With contracts permeating through the entire organizational and operational structure of a business, it makes sense that prioritizing these processes will provide you with the biggest benefit.
Contract risk mitigation remains one of the challenges for legal teams and contract managers around the world. New contracting models require businesses to connect the strategic portion of the decision-making process with analytics and data generated from the company’s operational performance. Contracts carry vital business information that can help you unlock additional potential and generate valuable insights about the health and wellbeing of the business.
You can’t eliminate or avoid contract risks. You can only mitigate these risks to an acceptable level. The effective management of contracts using a digital, connected system provides you with all the information and data you need to establish robust controls throughout your CLM. Using contract risk mitigation can help you accelerate your digital transformation initiatives and unlock additional value from your current processes.
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