Posted by Nigel Wallis, partner at Legal Futures Associate O’Connors LLP
Like beauty, risk is in the eye of the beholder. A key business decision can be seen through one person’s eyes as a clever entrepreneurial market move and, through another’s, as a reckless bet-the-house punt.
It also depends on the point in time at which you view a decision. As Evel Knievel put it: “Anybody can jump a motorbike. The trouble starts when you try to land it.”
Most business decisions end up being codified in some form of contract. This might be a simple letter with limited future consequences, such as buying stationery or booking a conference room. Or it might be a more complex document with long-term and significant consequences for the future, such as a strategic partnership with a key business introducer or the procurement of a new practice management system.
Whilst both have contract risks, the failure of a stationery supply contract may result in nothing more than an inconvenience whereas the failure of a strategic partnership may completely disrupt the firm’s day-to-day operations or even impact the firm’s future value.
The contract price is irrelevant as risk can lurk in unlikely places. A back-of-a-fag-packet contract with a decorator which limits the decorator’s liability to £200 (because that’s what you’ve agreed to pay him) may seem innocuous enough.
But if the decorator’s blow-torch accidentally sets fire to your offices, and your insurers discover that, by accepting the limitation of liability, you’ve waived their right of subrogation against the decorator’s insurers, they will not be happy bunnies.
When you then discover your insurers are walking away from your fire damage claim because you failed to disclose this important contract limitation, you’re likely to be hopping too.
So, do we give our business contracts the attention they deserve? With things like staff contracts and office leases, the answer is almost certainly yes. But what about confidentiality agreements, hosting agreements, introducer agreements and insurance broker appointments? I dare say most of us would rather study Lord Buckethead’s election manifesto.
What then are the main contract risks? Leaving aside the commercial terms (the product or service description and the delivery and payment arrangements), here are our top 10 contract risks to look out for when someone pokes a contract in front of you for signature:
Risk 1 – Parties. This may sound painfully obvious, but it is fundamental that the contract is with the right counter-party, that the signatories have capacity and authority to form the contract with you and that you have carried out an adequate level of financial and reputational due diligence on the entity with which you are about to contract.
Risk 2 – Regulation. You don’t need reminding that the legal sector is heavily regulated. It is critical that the form of any contract you are about to enter into is not prohibited by your regulator and that the contract does not oblige you to do or omit to do anything which could cause you to be in breach of your regulatory obligations going forward.
Risk 3 – Limitations and exclusions. Keep your eyes peeled for any unreasonable attempts by your counter-party to limit or exclude their contractual or other liabilities to you. If you do spot any, try to amend them or at least understand the implications.
If any are likely to impact your insurance arrangements, seek advice from your insurance broker on securing your insurers’ approval. Conversely, check your own obligations to the counter-party to see if you need to limit or exclude your liability to them in any way.
Risk 4 – Trading restrictions. Watch out for any provisions seeking to restrict or limit your ability to trade freely with any other parties and challenge them, as appropriate.
Risk 5 – Best or reasonable endeavours. If a contract requires you to use your best or reasonable endeavours to perform an obligation, this is better than an unconditional undertaking to do something but it’s far from a slacker’s charter. Make sure you know what’s involved.
Risk 6 – Time of the essence. If a contract makes time of the essence for the performance of any obligation on your part by a certain date or time, failure to meet the deadline will enable your counter-party to terminate the contract and potentially claim damages from you. Be alert to these deadlines and be sure you can hit them.
Risk 6 – Termination. Understand the circumstances in which the contract may be terminated and what the consequences are likely to be.
Risk 7 – Warranties & indemnities. Make sure you know what, if any, contractual warranties and indemnities you are being asked to give and satisfy yourself that you can meet them. Flag them up to your insurance advisers if they are likely to impact your insurance arrangements as insurers don’t generally cover liabilities assumed under contract.
Risk 8 – Insurance clauses. It is increasingly common to see clauses imposing insuring obligation on one or other party, particularly where services are being outsourced. Make sure you spot them and seek advice on them from your insurance advisers.
Risk 9 – Confidentiality & data protection. Where a contract involves you sharing data with a counter-party, be alert to any confidentiality obligations you have and ensure that both you and your counter-party can comply with data protection regulations.
Risk 10 – Entire agreement. And finally, most contracts contain an entire agreement clause so if your counter-party has agreed or assured you of something, stick it in the contract.