Overview of 4 Common Contract Risk Types
By David Parks, Director of Product Marketing at Contract Logix
Contract management can be risky business. That’s because risk is inherent in any contract and in most cases, it can’t be avoided, it must be managed and minimized. After all, nothing ventured, nothing gained. Completely avoiding all risk essentially means you are completely avoiding all opportunities.
When managing risk, it’s important to understand the different types of business risk and the varying degrees of consequence they have for your organization. For contracts, the four most common risk categories include financial, legal, security, and brand.
In many cases, your contract risks are closely related to each other and often have a domino effect. A brand risk may trigger a financial risk, or a security risk may trigger a legal risk. A good example of this is with the Facebook and Cambridge Analytica scandal where private information was stolen from 87 million Facebook users. This security and compliance violation resulted in a $130 billion drop in Facebook’s market capitalization. In addition, it dealt a huge blow to the company’s brand with 40% of its users saying they were going to take a break from the social media application.
“Contract risk involves potential losses due to a buyer’s inability to pay or the terms of the agreement being broken.”
Financial risks, often categorized as credit, liquidity, asset-backed, and equity risk, are contract risks associated with the loss of money regardless of whether it impacts your top or bottom line. From a contract management perspective, it could be caused by missing a key contract date — such as a renewal — and either losing business or inadvertently continuing the contract term due to an automatic rollover clause. Another example would be a contract termination or compensation associated with missed delivery dates, milestones, claims, or warranty problems.
Legal risks arise when you have a breach of contract with the potential for legal accountability or litigation. There are several types of legal risks including regulatory, compliance, and dispute risks. For contract management, your legal risk could occur from missing contract obligations and compliance requirements such as HIPAA, HITECH, OSHA, Sarbanes-Oxley, or other regulations. It could also be a result of intellectual property (IP) infringement charges, improper or lack of using the right legal clauses, confidentiality disclosures, and other contract disputes.
Security risks can be attached to some of the highest profile and most severe consequences for your organization. This is because security breaches with your contracts often result in additional financial, legal, and brand (see below) issues. When managing your contracts, security risks exist by storing contracts in insecure locations, allowing everyone with contract access to have the same level of access to sensitive contract data, leaving confidential contract data unencrypted, and by using email to communicate sensitive information.
Brand risk is essentially your risk associated with negative public and customer opinion, poor employee morale, and is part of the aftermath of financial, legal, and security issues. Mitigating brand risk is more important than ever because bad news travels fast in today’s hyper-connected digital world and can quickly impact your brand reputation. This, in turn, can impact your financial performance and the cycle perpetuates.
The four most common types of contract risk are financial, legal, security, and brand risk. Given the importance of contracts for your organization, it’s critical to understand these different risk types in your contract management processes and take the necessary steps to identify, assess, and mitigate them.
Intelligent contract management software from Contract Logix helps you uncover hidden contracts risks while easing and automating your risk management. Our Express and Premium contract management products harness all of your contract data to help you perform risk management processes that would be impossible to efficiently execute manually or with make-shift contract management tools such as spreadsheets, shared folders, and email.
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