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Home arrow Sociology arrow A short guide to contract risk
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STEP ONE: BECOME CONTRACTUALLY LITERATE

This step starts with an understanding of the business and legal dimensions of contracts and the impact of contracts on successful business outcomes as well as the related risks. It requires a basic understanding of the laws that are relevant to the company's business deals and relationships. this step, which is the foundation for the success of the entire plan, goes beyond having contracts or legal experts available when an issue arises. It involves understanding when contracts are formed, even when a document bearing such title is not present; understanding both their visible and invisible terms; exercising informed judgment when negotiating and working with them; and knowing when professional legal help is (and is not) required.[1]

STEP TWO: RECOGNIZE CONTRACT RISKS AND OPPORTuNITIES

the second step focuses on recognizing and describing relevant risks and opportunities. this requires identifying sources of risk and opportunity, their causes, and potential consequences. But first, the objectives of the contractual arrangement— business objectives and legal objectives—must be determined.

the objective of completing a delivery project on time provides a simple example. Assume that we work for a supplier of production equipment that has a contract with a customer.

The completion date is approaching, and certain tailor-made components that are on the critical path are missing. Based on earlier experience with similar projects, we know that our on-time delivery depends on the timely arrival of those tailor-made components. We also know that our component suppliers do not always understand the time and place of delivery the way we do, despite the fact that we use incoterms trade terms in our orders. We will use this chain of events— our component supplier's late delivery causing our project completion to be late—as the cause of risk to illustrate Steps two to four.

Having identified the cause, we now turn to identifying the potential consequences of the risk materializing. We might have access to a contract summary or a review checklist that will help us ask the right questions and find the answers. Risk lists and review checklists are helpful when identifying potential sources and consequences of risk. Figure 6.2 is an extract from a sample contract risk list related to the consequences of breach, namely liabilities and remedies.

In our simplified example, let us assume that we identify two potential consequences of the risk of delay in delivery: the customer will not pay us on time, leading to delay of cash flow, and the customer will claim compensation from us for the loss it suffers due to our delay. While we have chosen to focus on this one risk in our example, Step Two will normally result in a long list of risks and opportunities that need to be prioritized. This is the goal of Step Three.

Extract from a supplier's contract risk list

Figure 6.2 Extract from a supplier's contract risk list

  • [1] For visible and invisible terms and the different aspects of contract literacy, seeChapters 2, 4 and 5 of this volume.
 
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