MANAGING RISKS JOINTLY: FROM RISK ALLOCATION TO TRUE RISK MANAGEMENT
Within the risk management field, contracts have been long known to be effective risk allocation tools. Discussion of contract risk management in this field has focused on risk transfer, indemnity and hold harmless clauses, along with insurance to cover contractually or otherwise assumed risks. While knowing when and how to use, require and respond to such clauses—or additional insured endorsements, waivers of subrogation, contractual liability coverage, and so on—is important, these issues are quite complex and can easily blur the big picture so that one no longer sees the forest for the trees.
Within the legal field, practitioners typically discuss contract risk in the context of legal risk. Lawyers are often asked to examine the legal aspects of contracts, with limited or no access to information about the operational details of the deal, relationship, or project in question. Their assessment of risks embodies a legal perspective that focuses on risk allocation, risk transfer, and excluding or limiting liability in the contract, before the contract is executed. They are seldom involved in ensuring delivery of the obligations or monitoring performance, unless a legal dispute arises. the traditional lawyer's focus is on "spotting legal issues” and on contractual mechanisms that can protect the lawyer's client, rather than on the success of the project or the relationship.
In today's extended supply networks, where businesses are increasingly dependent on one another, it is no longer meaningful (if it ever was) to attempt to transfer all risk to the other party. instead, the focus should be on ways to manage risk together. in addition to the parties' focus on their own risks and interests, they should ideally engage in joint risk management, focusing on the risks to the overall project or venture.
The parties should use their pre-contract processes, negotiations, and contracts to recognize risks together and build in controls that help prevent or minimize the causes, likelihood, and impact of risk. To succeed, parties must even recognize risks that are hidden in boilerplate or invisible terms. Risks must be identified, understood, and acknowledged by both parties, and both need to take part in finding solutions that help mitigate the risks. in addition to pre-contract risk recognition, review and response, the parties should work together during implementation so that risks continue to be mitigated, monitored, and managed throughout the contract lifecycle. A cooperative and relational approach is called for, rather than confrontation and a focus on contractual risk allocation.
The time has come to change the decades-old way of thinking about contractual risk management as contractual risk allocation or contractual risk transfer, which are only a small part of what true contract risk management is about. Contracts offer much more for risk management than limitations of liabilities and remedies, indemnity and hold harmless clauses, and so on. A proactive approach necessitates—and enables—a big picture view and can pave the way towards the parties managing risks jointly.