There is no opportunity without any risk. If you fail to take a shot, you miss 100% of the opportunity. Given that risks are inevitable in contracts, how are you managing the contract risks in your organization when your contracts are growing in volume? Some risks can be avoided, while most can be minimized or controlled. Are you able to identify all the risks and create a mitigation strategy?
Today a typical Fortune 1000 company has 20,000 to 40,000 active contracts at any given time. Several teams have their arrangements, operations, obligations, and relationships outlined in these contracts. It is virtually impossible to keep track of each term in the contracts and assess an accurate risk exposure without an enterprise-wide system to manage the active contracts portfolio.
Without a contract risk management system, financial, sales, and legal teams are struggling every day with;
- No proper insight into business policies or contract processes at a critical time of negotiation
- Vague and unclear understanding of the cause and effect of various contract clauses on the business
- The ambiguity of the future economic health of the company based on the current contract portfolio
- Regulatory policies and procedures that have the potential for non-compliance
- Inadequate or inappropriate wording or usage of terms and clauses leading to legal exposure and lawsuits.
Contracts are a guideline, not a guarantee, and contract risks hit your bottom line. Organizations treat contract risks as lesser probability risks but seldom realize they have huge impact. Most organizations cannot manage voluminous and complex contracts and often follow an inefficient contract risk management strategy reacting to risks only after it has occurred rather than acting proactively.
What is contract risk management?
What are the key contract risk areas?
What are the challenges with the traditional approach to contract risk management?
What are the primary benefits of creating a risk-aware contract management culture?
How to increase contract compliance with Ultria CLM?
What is Contract Risk Management?
Contract risk management assesses and manages contract risk throughout the contract lifecycle. It assesses various contract risk areas including the loss of business opportunities, legal exposure at unforeseen circumstances, and the potential business impact of the contract on the organization. At every stage of the contract lifecycle, it should be able to assess the accurate amount of risk contained in the contract. Not just for one contract, at all times the contract risk management strategy should assess the total risk contained in the entire organization’s active contract portfolio.
What are the Key Contract Risk Areas?
Contract risk usually involves a potential loss to the business and its reputation due to the violation of the terms of agreements of the contract by one of the parties or the buyer’s inability to pay. There are 6 key contract risk areas and they are usually interrelated or create a domino effect when one contract risk occurs.
Any risk that is associated with loss of money is a financial risk in a contract. A key contract date, delivery date, milestones, or claims can be missed leading to payment of compensation or penalty. Contract terms may be violated by delivering unacceptable quality of products or failure to deliver or pay on time resulting in significant financial losses. An underperforming contract may be continued due to auto-renewal clauses. Contracts may be terminated on short notice or there may be warranty problems. These losses may affect your top or bottom line.
Any risk that is associated with a breach of contract leading to litigations or legal accountability is a legal risk in a contract. Parties may fail to perform their contractual obligations as per the contract invoking the penalty clause as well as attracting lawsuits. Contracts may be poorly drafted without proper understanding of key clauses like confidentiality clauses, disclosures, intellectual property infringement clauses, etc. or they may be completely missed out giving rise to legal complexities and issues. These risks may lead to the loss of your business reputation.
Any risk that is associated with a breach of confidential information or leakage of sensitive data to the public or competitors leads to a security risk in a contract. Contracts may be stored in an insecure location. Confidential information may be unencrypted. Everyone can access all contracts leading to access to sensitive contract data as well as inside confidential information leading to loss, theft, or leakage. Emails may be used for contract data communication that is not fully encrypted end-to-end. Security breaches are usually high profile and cause severe consequences to your organization by further causing financial, legal, and brand risks.
Any risk that is associated with the reputation of the organization’s brand name and negative publicity is a brand risk in the contract. Negative public and customer opinion, low employee morale, unsuccessful client collaborations, poor reviews, and inability to compete with competitors lead to poor brand image. In most cases, it is a consequence of financial, legal, and security risks. These risks need to be mitigated quickly as in today’s digital world – word spreads fast, especially negative feedback tends to get cascaded far too quickly. Impacting brand reputation and financial performance.
Any risk that is associated with an operational mismatch or deviation from internal standards is an operational risk of the contract. Contracts may not adhere to internal standards. Internal teams may not be in sync with their roles and responsibilities with regards to contractual obligations and they are not met on time. Third-party contract agreements may be different from organizations’ standard contract templates. Usage of contract language is not as per your organization’s standards leading to confusion and clarity over certain clauses. These risks cause operational inefficiencies leading to poor performance of the contract.
Any risk that is associated with non-compliance towards standard business processes, government, and industry regulations is a regulatory risk of the contract. Contracts may be poorly convened without attention to location legislation. They may not adhere to applicable government and industry standards. They may not be modified to changes in government and industry regulations. They may not comply with your regular business process. Non-compliance with these regulations leads to legal action, fines, and even termination of the contract.
What Are the Challenges with the Traditional Approach to Contract Risk Management?
Most organizations today have a traditional approach to their contract risk management, where they react to risks after they have occurred rather than act proactively and manage contract risk on an ongoing basis.
Their risk management strategy is usually an isolated process not scaled across the enterprise. They use stand-alone applications like governance risk compliance tools, data privacy tools, etc., or manual methods that do not span the enterprise or connect all the business processes. Organizing risk as a separate function provides only hindsight and not a holistic view of risk across your entire business. It does not usually address the following key challenges that are exclusive to determine the risk profile of the entire business and create a mitigation strategy for real-time protection.
Ad Hoc onboarding of third parties
There is no standard procedure for onboarding customers, vendors, and other third parties of the contract into your organizations’ channel, and it is ad hoc. The process is fragmented across departments and regions, increasing the probability of non-compliance with stringent ‘Know-your-customer” details. The non-standard procedure seldom takes into account contract compliance with anti-money laundering regulations. This leads to a vague and unclear vendor, customer, or third-party risk profile, leading to a higher probability of risk exposure.
A contract involves multiple departments. But without seamless integration between them, they may not be on the same page with the latest version of the contract. Due to a lack of organized workflows, they are liable to be ignorant about their roles and responsibilities, have misleading information, and have unclear contract data. This leads to an inaccurate assessment of risk data and risk categorization.
Ineffective one-off risk assessments
Instead of monitoring contract performance regularly, organizations conduct one-off risk assessments. This is ineffective and does not keep a check on the performance of contractual obligations by contracting parties on an ongoing basis. The quality and quantity of deliverables as well as the timelines are not monitored regularly leading to the risk of faulty goods, lesser quantities, and delayed deliveries. This significantly impacts the contract performance.
Insecure data storage
Contract data are stored haphazardly in insecure locations that are not encrypted end-to-end. Everyone involved in the contract has access to all contract data leading to data breaches, leakage, and usage of sensitive or confidential information by unauthorized personnel leading to security risks. There is a high possibility of losing contract data without a proper way to organize and store them, exposing them to contract risks.
Lack of visibility
All contract risks are contained in the contract agreement. But when organizations deal with thousands of contracts without a unified view, they lack visibility into their contract obligations embodied in their contract data. Inability to pull up contract information instantly and a limited view can lead to substantial risks. It can also prove catastrophic if certain obligations are not met in time and adversely affect the business’s reputation.
What are the Primary Benefits of Creating a Risk-aware Contract Management Culture?
Contract risk management today should not be a stand-alone process, but embedded in the day to day to operations of the business. Creating a risk-aware management culture makes your internal teams and clients aware of the contract risks at all times allows them to account for them before they occur. Scaling your risk assessment and mitigation strategy across your enterprise and involving all stakeholders can create an effective risk-aware contract management culture that can prove beneficial to your organization to,
Easily spot agreements that need attention
Those contracts that need attention and areas where problems may occur are brought to focus. It constantly monitors if obligations are performed and if the contracts will succeed or fail. These insights help them to review and manage significant risks in the contract and act proactively before any damage occurs.
Organizations won’t react to risks after they occur. A holistic view of the risk profile enables early identification of potential risk areas. Before risks can cause a deafening impact, they are intervened and worked upon mitigating losses thereby reducing their financial impact on the business.
Make better decisions with quality data
Organizations no longer have a limited view of the contract data. They can access the correct contract data. It allows them to analyze the success rates of contracts and decide when entering similar future agreements. They can profile the risk of current active contracts. This will enable them to decipher the loss capacity the organization can afford, creating better deals with contracting parties.
All your teams are in sync. There are on the same page with the updated versions of the contract. They are aware of their roles and responsibilities concerning their contractual obligations. They are prompted at regular intervals to perform their obligations for the contract’s seamless performance, minimizing risks and increasing success rates.
Improves financial planning
Incorporating a risk-aware culture into your financial process allows you to assess accurate budgets without guesswork. The financial losses the organization can afford are determined by entering into contract agreements where potential financial risks do not cross that threshold. It minimizes losses and improves the overall financial planning in the organization.
How to Increase Contract Risk Compliance with Ultria CLM?
An enterprise-wide contract risk management structure is essential to create a risk-aware contract management culture in your organization. Ultria solution with inbuilt contract risk management tools powered by AI offers a proactive analysis of a risk matrix and mitigation strategy. An end-to-end contract lifecycle management solution provides complete visibility by managing every contract stage from initiation, approval, drafting, vetting, executions, renewals, revisions, and terminations in a single cloud-based platform. It is equipped with essential features to help organizations become cost-effective by mitigating risks and increasing contract risk compliance.
Standardized contract creation-
The contract language is complex. Ultria CLM has an inbuilt pre-approved clause and template library so that contracts created are always as per standards. This enables to reduce risk exposure due to vague and inconsistent terms and clauses. The AI-augmented CLM tool enables to pick the right templates and clauses for a given contract providing consistent provisions and eliminating guesswork. This helps to mitigate risks during the assembly process. The clause library is kept up to date for changes in the business climate and standard regulations, and any changes get automatically reflected in the corresponding contracts making them compliant
Reduced Supplier Risks-
When suppliers fail to perform, it is an inherent risk to contract performance. Ultria CLM has a well-built contract repository software that indexes and stores the entire contract data and related information in an organized, single unified space. Existing contracts of any standard format can be scanned and stored through OCR. Built with AI-powered metadata and free text search, even if organizations conduct business with many suppliers and partners, their details can easily be captured. In case of unforeseen circumstances, it is easy to pull up the relevant data with supporting documents and adopt corrective measures accordingly to reduce supplier risks.
Review third-party agreement-
Contracts are created across different segments and borders. Third-party agreements may follow their internal standardized contract language. Ultria CLM contract risk assessment tools redlines those clauses and terms that are deviations from your organization’s standard contract language. These terms can be brought for negotiation or amendment before signing the contract to avoid operational or financial risk. A further lawyer trained AI tool highlights key clauses like Force Majeure, which was evoked during the pandemic early on to identify the course of action to minimize significant risks.
At every process of the contract lifecycle from initiation to renewal, there may be changes in scope, duration, or project details for the improved performance of the contract. Ultria CLM tools support contract addenda and amendments. It redlines changes and maintains an audit trail as well as version control so that multiple departments working on the contract have access to the latest version of the contract to make informed decisions.
Automated risk assessment-
Ultria CLM system sets a predesigned digital workflow in motion as soon as the contract is initiated. This automated workflow automates the risk assessment process and can generate risk reports on request. This enables organizations to establish benchmarks and make data-driven decisions. This paves the way to address risk issues before they occur, and supported with an audit trail, organizations can negotiate better during renewals for efficient contract performance.
Mergers and Acquisitions
During mergers and acquisitions, contract due diligence is critical. Who can access the information before, during, and after a business accepts another company or is acquired can heavily impact the process? While risks can’t be prevented entirely, Ultria CLM stores all information in a secure cloud-based contract repository. Only those who have permission can access high-level sensitive data with user-defined access and encryption. Regardless of the locations of users worldwide, it controls who can access, print, share, or email files from the portal. Allowing people to access information with a click of a button, the negotiation process is accelerated. The continuous tracking, monitoring, and management of the deal minimizes inherent risks and mitigates the risk of leakage of the pending M&A deal prematurely.
Milestone and obligation visibility
Obligations have to be met on a set due date for the seamless performance of contracts. Ultria CLM connects multiple departments involved in the contract on the same page. It designates roles and responsibilities for obligations to the right departments making them highly visible. These key dates or milestones are brought to notification of concerned departments with unlimited automated alerts and reminders to take action. This eliminates missed milestones and non-performed obligations which can cause a huge legal and ultimately substantial financial impact on the organization.