How to Identify Risk in Your Contracts
By David Parks, Director of Product Marketing, Contract Logix
Risk management is an increasingly important function for a lot of organizations as part of their overall governance, risk, and compliance (GRC) strategy. In addition, risk management and contract management have an important relationship. That’s because all contracts contain risk, whether it be legal, financial, brand, and/or security risk. Therefore, effective contract management can and should play a big role in a company’s successful risk management efforts.
Many different risk management models and approaches exist. Depending on how in-depth the process, the number of risk management steps can range from just a few to ten or more. Regardless of the number of steps involved, they are largely based on three foundational risk management activities: identifying, assessing, and mitigating risk.
This article looks at how to identify risk in your contracts and how contract management software is key to that process. I’ll be publishing additional articles over the next few weeks to address the steps for assessing risk and mitigating risk.
Steps to Identifying Risk
In order to assess and mitigate risk, you first need to know how to identify risk in your contract management processes by pinpointing where it exists. As part of the risk identification step, you need to answer several questions to better understand your organization’s exposure, including:
- Which contracts have a higher exposure to risk? These can be identified by evaluating contract types such as MSA or SOW, value, financial terms, privacy requirements, contract age, the use of certain clauses, or other data points.
- Are there parts of your contract management process that introduce risk? For pre-execution, this could involve workflows, timeframes, or other factors associated with contract creation, negotiation, and approval. For post-execution, it could be how you store and manage existing contracts.
- Are there vertical-specific regulatory compliance risks that you need to manage in your contracts, such as HIPAA, OSHA, DFARs, PCI, or others?
- Are there geographic regulatory compliance risks that you need to manage in your contracts with parties located in different states, countries or legal jurisdictions, such as GDPR in the EU or PIPEDA in Canada?
To identify and document as many risk factors as possible, it’s a best practice to establish a cross-functional team to help with the process. At a minimum, you want representation from every department involved in the contract lifecycle. This could include sales, procurement, finance, legal, IT, and operations.
This is especially true if you’re identifying risks across both buy-side and sell-side contracts. For example, sales contracts or licensing agreements would be on the sell-side. Procurement, intellectual property, vendor agreements, or outsourcing would be on the buy-side. In some cases, the contract might span both buy-side and sell-side, such as with a nondisclosure agreement.
How Contract Management Software Helps Identify Risk
Contract management software such as Contract Logix’s intelligent contract management platform can play a key role in identifying contract risks, especially as part of a broader digital transformation initiative that includes your contracts and processes. Here are just a few examples of how it helps.
Centralize all Your Contracts in a Secure Electronic Repository
In order to identify risk in your contracts, you need to have an accurate inventory of all your contracts and their collective content. Storing contracts in shared folders across multiple locations and formats is risky because it makes taking this inventory nearly impossible and lacks governance, accessibility, and security. A better approach is to centralize your agreements in a password protected and cloud-based contract repository. It keeps your agreements organized, greatly reduces the risk of them being accessed by the wrong individuals and stores them in a safe place. It also allows you to securely access any document at anytime from anywhere on any device, and structures the data associated with your contracts in a format that makes it easy to search and filter.
Establish Benchmarks and KPIs to Identify Potential Areas of Risk in Your Processes
Once you centralize your contracts and related documents and make the data searchable within your contract management system, you can put that data to work. You can do this by developing benchmarks and key performance indicators (KPIs) to help identify areas of risk in your contract management processes as well as track the stage and status of every agreement in your process. Some examples include:
- Number of contracts by stage, type, and status
- Number of contracts by owner and organization
- Number of contract requests, requests by type, and by timeframe
- Average number of days in a contract lifecycle
- Average time to reach and execute milestones
- Number of missed milestones
- Number of improperly executed contracts
- Average time required for overall contract approval
Understanding how to identify risk is a critical part of an overall risk management strategy. Effective contract management plays a major role in risk management because risk exists in every legal agreement. Contract management software simplifies the process for identifying risk and provides a number of significant advantages to making your risk—and contract—management efforts more successful.