A proper legal risk management process is critical for the preservation of a healthy contracting process. Failure to adequately manage contract risk can be disastrous. Harmful contract risk oversights affect not only legal teams – but organisations as a whole.
Your organisation should work to avoid a breach of compliance, violation of contract terms, lost revenue, wasted time, lawsuits and a damaged company reputation by addressing different types of contract risks. As such, let’s break down agreement risk management and how it can be maximised with contract management software.
What is contract risk?
Contract risk is the potential for losses or harmful outcomes arising from the terms and conditions of a contract or from the failure of parties involved to address the obligations of the contract. These risks can occur for a variety of reasons – including ambiguous contract language, party non-performance, financial instability, or changes in compliance laws and regulations. Contract risk is significant because it can lead to financial losses, business relationship damage, legal disputes, and wasted time. Managing contract risk correctly involves due diligence, a clear and precise contract creation process, regular observance of contract performance, and mitigation strategies. The goal is to minimise potentially negative impacts on businesses and ensure that all parties retain a clear understanding of their responsibilities and the consequences of failure of contractual obligations.
What Is contract risk management?
Contract risk management involves using risk assessment tools to evaluate potential risks a contract can incur. Such risks include financial risks, regulatory compliance risks, breach of contract, security risks, and others. Risk can prevent effective contract management. So, a contract risk management strategy is non-negotiable.
Breaking down the contract risk management basics
Now you know how to define contract risk management. Let’s break down the basics of contract risk management and how to use contract management software risk mitigation tools.
1. Establishing risk appetite in contract management software
You can begin your contract risk management process by establishing a contract risk appetite within your contract lifecycle management software system. Risk appetite is the acceptable risk your organization is willing to incur in pursuit of smart goals for contract managers and broader contract management KPIs.
With a a contract management risk and opportunity assessment tool, your organisation can proactively map risk and risk exposure variables. You can establish risk acceptance policies and guidance by contractual risk category to be dynamically visualised and analysed. As such, your team can quickly identify items that fall outside of your acceptable range of risk and quickly address them.
2. Diving deeper into risk with a risk assessment matrix
In addition to managing acceptable risk and your organisation’s risk appetite, your organisation can further supercharge risk goals.
You can easily classify significant risk categories depending on your hierarchy of contracting needs. You can rank and identify contract risk events and their probability to establish an understanding of events that would negatively impact your organisation. For high-risk contracts, vendors and purchases, your organisation can review and log risk events and quantify risk.
With the ability to monitor risk in such a powerful and visual way, your organisation can reduce risk and even avoid some risks altogether. You can recognise trends and implement routine risk reviews. You can implement strategies and best practices to reduce risk exposure and probability.
3. Automating contract data mining and identification
Leading contract management software can empower your contract managers’ contract risk administration.
Contract AI within CLM software can allow you to identify key contract data fields and establish rules around them. These sensitive data points can include PCI (payment card information), PII (personally identifiable information), counterparties, email addresses and financials etc.
With drag-and-drop contract authoring, your system can use NLP (natural language processing) to automate the population of data fields onto a tidy contract record page. This feature can significantly streamline the mapping of contract language onto your organisation’s pre-approved contract metadata fields.
You can also configure contract clause detection rules. These rules help you compare newly introduced clauses against those within your approved library and contract database.
When a contract is introduced, you can pinpoint possible risks. By analysing standard contract language (such as intellectual property clauses, confidentiality clauses, and others depending on the type of contract), your system can identify positive and negative aspects of language. This identification is based on configured rules and exposure to up to one million contract clauses. A contract risk management system that has been exposed to numerous clauses and hypothetical risk events can give your organisation unparalleled risk oversight.
4. Observing hands-on risk reduction actions
Let us examine some important actions that can typically reduce contract risk.
- Generating a contract amendment
- Renegotiating a contract to reduce risk
- Transferring risk to a third party
- Offsetting liability by purchasing insurance
- Considering carve-out transactions to subset liabilities to a larger enterprise
- Running risk audits and establishing robust security controls
- Seeking Third-Party Legal Advice.
- Contract Termination (if done correctly)
5 .– Establishing a contract risk AI machine learning schedule
Capitalising on the robust contract intelligence use cases mentioned before, your organisation can leverage contract AI to learn from new data and contracts. Contract AI can also learn from changes to existing contracts. This machine learning can take place on a scheduled basis – depending on your organisation’s needs.
For example, your system can be used to schedule recurring contract risk analysis with machine learning:
- Yearly
- Monthly
- Weekly
- Daily
- Hourly
You can also configure when a recurring risk analysis with machine learning may take place. For instance, maybe you would like this recurrence to take place on the first day of every month.
You can edit, delete, or view an analysis job as needed – as contract complexity and contract volume grow.
In addition to analysis, rules can be configured to enable a contract AI engine to make intelligent recommendations based on analysis data. Your organisation can be equipped with a rules-based strategy to recognise risk and evaluate it.
For an even more advanced intelligence strategy, you can configure your criteria to update over time. For example, your contract managers may want to determine If financial exposure is too high for the price of a contract.
On-screen alerts can give your organisation front-end awareness of potential risks. This process can be continuously improved with more contracts and relevant data introduced.
Get started with these risk tools and strategies
Now that you are up to speed on contract risk management processes, it’s time to get started. All that’s left is to select a contract risk management solution that can help you with all the strategies mentioned above. That solution is Contract Insight from Four Business.
Four’s Contract Insight is a secure, acclaimed procurement software used by organisations in a variety of industries within public procurement spaces and private sectors.
To find out more, contact John O’Brien, CEO at Four Business Solutions – global business consultants and software integrators specialising in business process improvement.