Contract Risk Definition: Everything You Need to Know
The chance of facing losses as a result of the buyer not fulfilling the terms of a contract, not including if the buyer is incapable of paying.3 min read updated on January 01, 2024
A contract risk definition is typically one of two things.
1. The chance of facing losses as a result of the buyer not fulfilling the terms of a contract, not including if the buyer is incapable of paying.
2. The chance of facing losses from the deal performing poorly. Sellers face the most danger in fixed-price contracts and the least in cost-type contracts.
Basic Guidelines for Contracts
Contracts are agreements between two or more parties that outline how they will function together, as well as what regulations and limitations will be involved. These agreements can be spoken, or penned in official documentation.
Several elements must be present in a contract for it to have any effect in the US:
- Every party in the contract must be providing something of value to some other member of the contract.
- A proposal must be made, followed by an acceptance by one or more other parties.
- Unless otherwise stated, the contract must be created with the intention of it being legally binding.
- There must be a legally actionable purpose if it is meant to be enforceable by the US government.
- All members of the contract must understand what it is they are agreeing to and be capable of agreeing to such a contract.
During deliberations between parties, and BEFORE any signatures are made on any legally binding documents, considerations must be made as to whether or not the risks of the agreement have been appropriately confronted. This should be done with a competent person, who was not involved with the negotiations, having a look over the documents.
Contract Risk Management
All business endeavors involve taking on risks to some degree. With that said, there are steps that can be taken to tone down these risks and ensure that you are getting the most value out of every deal.
For the most part, there are two types of contract risk:
- Risks involving legal accountability such as breaches of contract and infringements in intellectual property.
- Risk surrounding the image and operations of the business such as poor staff morale and negative public opinion of the company.
These risks are a prominent source of headaches for many businesses but are all preventable with proper assessment along with the implementation of preemptive measures.
Steps of Contract Risk Management
Management consultant John E. Miller published a document about contract risks where he listed steps that companies should take when facing contract risks:
- Discuss with people from various sectors of your organization to determine risks.
- Evaluate and estimate the likelihood and severity of the risk involved in the contract.
- Consider if any high-risk work is worth taking on. If not, reject the project as necessary.
- Try to build a relationship with financially stable and agreeable companies.
- Subcontract and outsource work to share part of the risk involved with the project.
- Utilize insurance to lessen costs in case of failure.
- Take steps to avoid, eliminate, transfer, or bear the risks to decisively alleviate them.
- Find solutions to counteract the risk and render it harmless.
- Develop strategies to control and manage the risk.
- Ensure the quality of every agreement and document related to you and your company.
These steps should function like clockwork within your organization. Otherwise, you'll find yourself inundated with unforeseen issues at every corner. By that point, it will be far too late to apply measures to offset the damages.
Allocation of Risk
Contractual risk transfers are agreements between cooperating entities defining who should shoulder responsibility in the case that losses are incurred because of the deal. This can be done through:
- Having one party compensate for losses taken by another party
- Restricting the amount of damages that can be pursued
- Preventing subrogation by insurance companies or similar organizations
Contract Risk and Compliance: Is Stability Possible in the Current Environment?
The real problems with contract risk management are when companies have too many parties to deal with. Smaller companies just don't have the time or resources for the job.
Despite how daunting of a task it is, companies are slowly appreciating the value of a well-conceived contract compliance system. These include regular inspections of their partners' operations.
This has given organizations invaluable knowledge about previously unconsidered risks, which can then be discussed and resolved. These resolutions strengthen bonds between companies and often improve efficiency overall, leading to profits for all parties involved.
If you need help with contract risk, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.