Contract Risk Reduction 101: 12 Tips & Tricks
How important is contract risk reduction? The answer is — very! Every contract you sign carries with it some degree of risk, and it’s important that you reduce these risks as much as possible. Fortunately, there are several steps you can take to mitigate your contract risk, as you will learn in this article.
- All contracts carry inherent risks
- Contract risk mitigation is the process of reducing the possibility and impact of contract risk
- To reduce contract risk, standardize contract creation, use preapproved clauses and terms, maintain strict version control, and automate CLM processes to follow business rules and track obligations
- The easiest way to mitigate contract risk is with contract lifecycle management software from Contract Logix
What Are Common Contract Risks?
Contracts are risky. There’s always the risk that the other party doesn’t live up to the agreement or that you somehow can’t deliver on the contract terms. Responsible contract management works to reduce or transfer the inherent risks in each contract, which means recognizing where contract risk can occur.
Contract risk can be financial, legal, operational, or compliance in nature. The most common risk-related issues include:
- Unfair terms
- Unprofitable terms
- Lack of visibility for contract contents
- Missing contract deadlines or obligations
- Missing opportunities to renegotiate
- Noncompliance with industry or government regulations (can cost up to $15 million per violation, on average)
- Breaching local, state, or federal laws
- Breaching the terms of the contract
- Lost or misplaced contracts
- Unauthorized access to contracts
According to KPMG, inadequate contract risk reduction can result in a 9% loss of contract value. To avoid this contract leakage, contract management needs to avoid or lower these and other contract risks.
(The following video goes into more detail about the various types of contract risks and how to mitigate them.)
SOURCE: Identifying, Assessing and Reducing Contract Risk via YouTube
What is Contract Risk Reduction?
Reducing the opportunity for and the cost of contract risk is called contract risk reduction. The goal of contract risk mitigation is to achieve the goals of the contract while reducing the likelihood of nonperformance or noncompliance.
Contract risk reduction should be a holistic strategy embraced by all departments and employees who work with contracts in your organization. It can be achieved by careful management of the entire contract process, which is made easier by the use of contract lifecycle management (CLM) software, such as that from Contract Logix.
Tips and Tricks to Reduce Contract Risk
How can your organization best mitigate contract risk? There are a number of risk mitigation strategies you can employ, the most effective of which are presented here.
Create a Contract Risk Team
To get serious about mitigating contract risk, establish an internal risk mitigation team. This team should consist of qualified individuals from all relevant departments (legal, accounting, procurement, sales, etc.) charged with identifying and reducing systemic risk in your contract management process. They should also be the first to deal with and try to mitigate identified risks.
Recognize, Review, and Respond
The typical risk mitigation process consists of three stages: recognize the risk, review the risk, and respond to the risk. Applied to contract risk mitigation, you end up with the following process:
- Recognize the risk by identifying the issue and what caused it
- Review the risk by estimating the risk’s probable impact and then prioritizing it
- Respond to the risk by taking measures to mitigate both the likelihood and impact
Prioritize the Risk
The reality is that not all risks are created equal — and you may not be able to deal with all risks equally. When you identify a specific contract risk determine how likely the risk is to occur and the probable impact of that risk. Prioritize risks that are more likely and more likely to have a larger impact on your business. When doing this prioritization, it’s a good best practice to score the risk based on the probability or consequence using a 1-5 or 1-10 scale.
Standardize Contract Creation
One effective way to mitigate contract risk is to make sure that all contracts adhere to standardized form and language. The best way to ensure this is to implement a contract clause & template library from which future contracts can be built. You should discourage ad hoc contract creation and formats, as this is riskier than using standardized, preapproved contract types and templates.
Use Preapproved Clauses and Terms
Similarly, you don’t want employees inserting rogue clauses and terms into your contracts. Instead, require employees to use of standardized clauses and terms that have been preapproved by your legal and contract staff and housed in your clause & template library. Some CLM software solutions like Contract Logix will then automatically populate certain clauses into your contracts based on conditional rules, further mitigating the risk of using the wrong language.
Automate Contract Workflow
Automating the contract workflow reduces the risk of introducing errors into the process. Automated contract workflow ensures contracts will not be lost and that the proper review and approvals will occur – and that rogue employees won’t be able to circumvent the system by inserting risky terms and language. They also give you a complete audit trail and history of who did what in the event of a dispute.
Maintain Strict Version Control
When multiple people are redlining different versions of the same contract, they introduce risk. This highlights the need for strict version control. Accurately tracking changes made by all users reduces the risk of duplicated, missing, or inaccurate data in the contract. Again, CLM software from Contract Logix supports real-time contract collaboration and automated versioning and tracking making this very simple to accomplish and manage.
Conduct Frequent and Thorough Contract Reviews
Risk can be introduced at any stage of the contract process. For this reason, it’s important that you conduct thorough contract reviews at all stages of the contract process and beyond— post-execution. Reviews can be both internal and conducted by third parties, and include:
- Legal reviews for legality and compliance
- SME reviews for technical accuracy
- General reviews for internal due diligence
Centralize Contract Storage
Risk is multiplied when contracts are executed and stored in multiple departments and locations. To reduce risk, introduce a centralized contract repository, preferably digital, for all your contracts. This repository should be based in the cloud and have the appropriate security capabilities that you can configure. Examples of key security features you will want in your CLM software include SOC 2 Type II compliance, roles-based and features-based permissions, authentication settings, and data encryption.
Limit Access to Contracts
By enabling centralized storage, you can more easily limit access to your contracts. You want to limit access only to authorized users, which you can do by monitoring user permissions and embracing a Zero Trust access policy. This helps keep contracts out of the wrong hands and minimizes the risk of data theft or attack.
Automatically Generate Reminders and Alerts
One of the bigger risks in contract management is missing scheduled deliverables and deadlines. Contract lifecycle management software includes automatic notification of upcoming deliverables, so you’ll never miss a deadline again. You can very easily track key dates, obligations, milestones, and more without any manual intervention.
Use CLM Software
Most of these tips and tricks for contract risk mitigation are easy to implement when you embrace contract lifecycle management (CLM) software. CLM software, such as that from Contract Logix, automates the entire contract process from inception to post-execution so that the potential for risk is significantly lowered. It’s the easiest way to mitigate contract risk in your organization.
Let Contract Logix Improve Your Contract Risk Reduction
When you want to seriously mitigate your organization’s contract risk, turn to the contract management experts at Contract Logix. Our CLM software automates all aspects of the contract lifecycle, saving you time and money and significantly reducing the possibility of contract risk. Your contract becomes more efficient while errors of all kinds are reduced. It’s the easiest way to bring contract risk mitigation to your organization.
Contact Contract Logix today to learn more about Contract Risk Reduction.