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What is Risk Assessment in Contract Management?
Risk assessment in contract management is about identifying the potential risks associated with a contract and evaluating their likelihood and impact. This process allows companies to make informed decisions about concluding a contract, negotiate its terms, and manage risks throughout the term.
By strategically implementing contract risk management practices, organizations can cultivate a culture that prioritizes streamlined contract management and enables internal teams to perform their tasks efficiently and with confidence.
What Are the Biggest Contract Risks?
The following are the main contract risks that companies must be aware of
1. Financial risks
Financial risks refer to contract-related threats that can result in financial losses, regardless of their impact on your organization's income or expenses. In contract management, financial risks can arise as a result of various factors, such as missed deadlines that lead to business losses, automatic contract extension, contract termination, or compensation for missed milestones, warranty claims or late deliveries.
2. Legal risks
When evaluating legal risks, it is essential to consider the possibility of breaches of contract, which could lead to legal action. Such situations can arise when contractual obligations are not met and contractual penalty clauses are triggered. In addition, the drafting of the contract itself also represents a legal risk, particularly if it is deficient, as it can lead to inaccuracies that result in legal disputes. Poorly worded contracts can contain critical errors, particularly with regard to intellectual property and confidentiality clauses, which can have serious consequences.
3. Safety risks
Security risks can have significant and adverse consequences for companies, which often have serious legal, financial, and reputation-damaging effects. Security risks associated with contract management can arise from contracts being stored in insecure locations, granting all users uniform access rights, and not encrypting confidential contract data. The use of email to transmit sensitive information also poses a security risk that should be carefully considered and managed.
4. Trademark risks
The risk associated with negative consumer and public perception and poor employee morale is commonly referred to as brand risk. It is an ongoing issue, even when security, legal, and financial risks are taken into account. In today's digital world, where negative news is spreading rapidly, reducing brand risk is more important than ever before. Damaged brand reputation can have a significant impact on financial performance and thus set in motion a cycle of negative results.
5. Operational risks
Operational risk in contract risk management refers to the risks arising from daily operational activities in contract administration. These risks include errors and omissions in data entry, ineffective or inadequate contract management processes, inadequate monitoring of contract performance, and failure to fulfill contractual obligations due to issues such as insufficient resources or communication gaps.
How Do You Carry Out a Risk Assessment of Contracts?
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The following explains how a risk assessment is carried out for contracts:
- Identify contract types: Start the contract risk assessment process by identifying the various types of contracts in your organization, such as customer contracts, supplier contracts, employee contracts, partnership agreements, and other legal documents. This first step enables you to identify specific risk areas and determine the potential impact of those risks on your organization.
- Review contract clauses and terms: It is crucial to carefully review and analyse the terms of the contract. Be sure to look for precise clauses on liability, warranties, compensation, termination, and dispute resolution. It is also important to identify any missing clauses that could jeopardize your business.
- Evaluation of the parties to the contract: The assessment of the parties to the contract, including their reputation, financial stability and compliance with legislation, is also necessary. This assessment will help determine the likelihood that the parties will meet their obligations and identify the potential risks associated with them.
- Determine the likelihood and severity of risks: This takes into account the likelihood of the risk occurring, its potential impact on the company and the effectiveness of existing risk mitigation controls. Risk assessment tools such as risk matrices, heat maps, or contract software can be used to visualize and prioritize risks.
- Mitigate risks: Once you've assessed the risks, you need to develop strategies to mitigate or manage them. This may include negotiating better contract terms, implementing controls such as insurance or guarantees, or creating emergency plans to address potential risks. To ensure that all perspectives are considered, it is important to involve relevant stakeholders, such as legal, financial, and operations teams, in this process.
- Monitoring and verification: It is critical to regularly monitor and analyse the contract to verify that risks are being managed appropriately and to identify new risks that may arise. This could include setting up a risk management structure that provides frequent reporting, tracking of key performance indicators, and effective communication channels for stakeholders.
Checklist: 7 Things to Consider When Evaluating Contract Risks
1. Use clause and template libraries
Non-compliance is a major source of risk for companies, and incorrect wording in contracts is a common reason for compliance issues. Fortunately, creating a library of contract clauses and templates can help mitigate that risk. By using language that has been previously approved by the legal department and general counsel, contract drafters can be assured that their wording has been properly reviewed. This not only reduces the risk of non-compliance with regulations, but also helps ensure that the wording is consistent across all contracts.
2. Contract security with role-based access
Controlling access to sensitive information is critical when managing contracts. Role-based permissions can provide the necessary control to ensure that only authorized employees can access or edit specific documents or contract types. By restricting access to sensitive and protected information, the risk of unauthorised access and sharing of sensitive data can be significantly reduced.
3. Encrypt contract data for protection
In contract management systems, the data stored in the system is considered “at rest.” Encryption should be carried out to prevent unwanted access to this data. All data that is transferred externally to or from users or applications is also considered “in transit.” To reduce the risk of data breaches, data should also be encrypted during transmission.
4. Ensuring contract fulfilment through automatic notifications and alerts
Using a contract management solution with automated warning and reminder features can reduce the risk of missed milestones and commitments. Alerts can be set up to notify the appropriate parties when a milestone is reached or a contract is pending renewal. This ensures that all parties are aware of critical deadlines and can take appropriate action to meet them.
5. Contract version control for effective collaboration
During the negotiation process, it is critical to maintain control over contract versions to ensure that all parties involved have access to the latest and most accurate information. This can be achieved by using a contract management system that enables real-time collaboration and version control.
6. Secure approvals with e-signature
Electronic signatures prevent contract approvals from being manipulated and reduce the risk of a paper printout being misplaced. They also provide an improved experience for approvers and enable mobility as contracts can be signed on any device, anywhere.
7. Exploit automated work processes
Manually tracking and simplifying the individual steps in the contract life cycle can be time-consuming and prone to errors. Automated workflows provide a streamlined and efficient approach to contract management and ensure compliance with organizational processes. By implementing automated workflows, companies can improve their contract management capabilities and, in the event of an audit, demonstrate contract compliance.
