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Contract Risk Mitigation: 8 Best Practices You Need to Follow

December 17, 2021

contract risk mitigation

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.

What is contract risk mitigation?

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.

How to manage contract risk effectively

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:

  1. Improved risk detection – Developing an ability to predict, anticipate, and observe emerging threats using data points from inside and outside the business. Companies need to use these datasets to quantify the magnitude of risks, impact and duration, and the plan on how to respond to risks effectively. 
  2. Delimited risk appetites – Taking on additional risks dynamically using the organization’s growth strategy, current value, and risk-mitigation and control capabilities when possible. This approach lets every accountable resource know what the right amount of acceptable risk is and where to set the right threshold. 
  3. Evolving risk management strategies – Establishing a risk management approach in your organization that generates feedback and performance indicators to inform any changes in your strategy. This includes how to respond, undertake, or mitigate risks based on internal and external factors. 

To build a risk management framework that can respond to changes effectively, McKinsey & Company recommends taking five separate actions. 

five steps required for dynamic and integrated risk management in an organization

Source: McKinsey & Company

What are the common contract risk types you should look for?

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. 

1. Regulatory and legal risks

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:

  • Service Organization Controls (SOC) 2 Type 2 – Reports and audits for all data security procedures, processes, and technologies
  • Payment Card Industry Data Security Standard (PCI DSS) – Maintains credit card information privacy and security
  • Federal Information Security Management Act (FISMA) – Governs data security at federal organizations
  • Health Insurance Portability and Accountability Act of 1996 (HIPAA) – Protects personally identifiable information (PII)
  • Health Information Technology for Economic and Clinical Health Act (HITECH Act) – Promotes the adoption of technologies for improving electronic health record (EHR) systems
  • Occupational Safety and Health Act (OSHA) – Aims to provide safer work conditions for all employees
  • Sarbanes-Oxley Act (SOX) – Governs financial record-keeping practices in publicly traded companies

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. 

2. Security risks

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. 

3. Financial risks

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:

  • Credit risks – Includes a variety of risks such as defaulting of a counterparty who fails to deliver according to the obligations of the contract
  • Liquidity risks – Describes the ability to pay out a contract before it reaches maturity without incurring unacceptable losses
  • Asset-backed risks – Are financial structures to separate and mitigate risks using instruments for the securitization of the organization’s exposure
  • Equity risks – Involves any equity position in another firm or venture that can expose your organization to additional financial risks when that entity fails to perform and the stock drops or your gains aren’t equal to the value you invested

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.

4. Brand damage

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:

  • Companies treat employees badly
  • Information about company practices leaks to the public
  • An incident occurs like a data breach or information leak
  • The organization doesn’t have adequate public or media relations strategies in place

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. 

Why should you mitigate contract risks?

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:

  • Avoid missing your contractual obligations including deadlines, milestones, key dates, or any other deliverable
  • Prevent the unauthorized access or dissemination of information relating to your organization, suppliers, employees, customers, or other legal relationships
  • Ensure compliance with internal policies, contractual thresholds, and external regulations or industry standards
  • Streamline the buy- and sell-side of your contracting process for increased efficiency
  • Provide better alignment with stakeholder strategies and reduce or prevent avoidable fines with legislators

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. 

Implementing a balanced approach to contract risk mitigation

Along with digital transformation efforts, organizations should adopt a balanced approach to contract risk mitigation. You can do this by:

  • Measuring acceptable risks against the value of new opportunities
  • Contrasting current revenues against any additional costs
  • Evaluating the potential of innovation against compliance requirements

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.

Best practices for mitigating contract risks

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.

1. Identify contractual risks

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.

2. Assess and score risks 

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.

3. Establish a contractual risk team

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. 

4. Digitize the contracting process

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. 

5. Use alerts and notifications

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.

6. Deal with the biggest risks first

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.

7. Streamline the drafting process

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. 

8. Review and optimize where necessary

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. 

Dashboard of a digital contract management system

Source: Contract Logix

Why should you use contract management software?

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.

With contract management software, you can:

  • Quickly find and report on your contracts according to any parameter or search criteria
  • Track your progress for each agreement and see how efficient your process is
  • Deploy new controls where necessary to avoid increasing your risk exposure
  • Complete the contracting processes without the need for in-person meetings
  • Create a standardized library for all your clauses and templates to speed up the lifecycle

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.

Don't take any risks 

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.

Want to learn more about best practices for saving your documents securely? Check out this quick guide on document storage.

contract lifecycle management clm software
Sign the dotted line

The lifecycle of a contract has many stages. From pre-signature to post-signature, let contract lifecycle management software help.

contract lifecycle management clm software
Sign the dotted line

The lifecycle of a contract has many stages. From pre-signature to post-signature, let contract lifecycle management software help.

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