Risk mitigation is always one of the most important objectives of contract lifecycle management (CLM). The legally binding contract is designed to reduce the risk of disputes, delays, litigation, and elevated costs.
The most important risk mitigation is completed far in advance of contract activation and takes a lot of planning and preparation. There are critical steps that should be taken early.
1. Understand the need for the contract.
It is important to drill down and identify the need for the contract in the planning stage before conversations even start with the other party. Ask yourself the following questions:
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What will this contract establish?
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What impact will this contract have on my business?
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What actions will be required of other departments as a result of this contract?
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Can we meet all the obligations of this contract?
2. Understand the risk landscape.
The risk landscape is constantly shifting. It is influenced by global market fluctuations, economic volatility, and political machinations. From public health issues and cyber threats to seasonal change and regulation overhauls - risk can take any form at any level. It is critically important to complete comprehensive risk assessments for the entire period of the contract.
Example: A contract signed in 2019 would need to consider the likely impact of Brexit. Likewise, a contract signed in 2020 or 2021 would need to consider the risks posed by the Coronavirus pandemic as well as the transition from the London interbank offer rate (LIBOR) to the secured overnight financing rate (SOFR).
3. Follow through with third-party due diligence.
Third-party due diligence is central to your early-stage risk mitigation strategies and must go well beyond surface-level inspections. It is critical to develop a thorough understanding of their risk profile and the ways it impacts the risk profile of your business. This preparation should include:
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Comprehensive background checks of businesses and individuals in terms of security, assets, current and past associations, political exposure, ultimate beneficial owners, and compliance histories.
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Examination of cyber security measures.
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Assessment of territory-based legislation and regulatory requirements.
The findings of this analysis can be used to advise the negotiation process, whether the contract should move forward or not, and actions needed within your own business to further mitigate risk.
4. Analyze past data.
Review similar contracts for concerns that came up in past contractual dealings, and search for data that details the performance of similar contracts. It is possible to identify risks and levels of risk that have not previously been identified.
5. Understand past mistakes.
Turn mistakes made in the past into teachable moments. Perform post-mortems to reveal performance issues or negotiation missteps and accumulate invaluable knowledge.
6. Establish red lines.
Red lines are recommended safety limits regarding the risk tolerance of your business. Determine how far you are willing to compromise before negotiations even begin. Your red lines should be communicated with absolute clarity and set boundaries for the contract negotiation team.
7. Create and use contract templates.
Use pre-approved clauses as the starting point for developing contracts. This saves time and takes the potential risk of human error out of the equation.
