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Ten Steps to Assessing Contract Risk

A critical component of any contract risk management strategy is to complete a contract risk assessment review for all contracts. No organization can operate risk-free. We need to take reasonable risks to maximize business growth and profits while at the same time recognizing the risks we take and minimizing their potential effect.

Contracts can expose an organization to financial, legal, compliance and/or operational risks; however, it’s possible to effectively de-risk a contract by conducting a thorough risk assessment and then working through that review to mitigate risk exposure. Overall, there are 10 steps to assessing contract risk; we’ll review five of them here, and five more in a future blog.

#1. Evaluate the Contract Obligations

The first step is to evaluate the scope of the contract. Ask the following questions:

  • What are our obligations under the contract?
  • Can we deliver on these obligations?
  • How much time and money will be involved in meeting these obligations?
  • Are there any “gray areas” where our obligations are not clearly defined and could end up in dispute?

#2. Review the Schedule 

Once we have effectively evaluated the obligations in the scope of work, the next step is determining how to manage those obligations. Each contract commits us to deliver a product or a service on a specified timetable. A few things to look for and be aware of are:

  • The schedule of deliverables and whether we can meet the delivery dates.
  • What penalties are involved if we miss the delivery dates? What is the financial risk associated with committing to a schedule?
  • What are the risks if our vendors, suppliers, subcontractors or other partners do not adhere to their contracted delivery dates?

Managing the contract obligations and deliverables is a critical risk management function.

#3. Review the Terms

Contracts involve a financial transaction. Either we are paying the other party for something, or they are paying us for a service or product. Pricing and payment terms must be reviewed to ensure the terms are fair to both parties. We want to avoid entering into an agreement where we risk non-payment, extended payment terms or being underpaid for delivering products or services to a client.

#4. Identify Location-Specific Obligations and Risks

Many contracts are entered into with clients who operate in different states and jurisdictions. Different states can pose various risks depending on the services provided to the client. These risks may involve local rules and regulations, such as different licensing or safety requirements, prompt pay acts, privacy regulations, etc.

#5. Evaluate the Contract Partner

Doing business with new vendors or customers is potentially riskier than with established relationships. It is important to properly research and assess a customer’s reputation, reliability, policies, principles and stability.

For example, if we are partnering with a new customer and security is a concern, do they have the proper security protocols and certifications in place? Do they perform employee background checks? Do they have a data privacy policy? What do we know about their financial performance? It is also critical to ensure all of the supporting documents for the contract are in place and up to date, like a Certificate of Insurance (COI) or a business license.

At FTI, contract risk assessment is an integral part of ensuring that our business needs are met, and our organization is protected. Stay tuned to the Faith Technologies blog for part two of our tips on assessing risk.