Contracts create substantial legal risks that threaten the organization. Careful management at the senior levels is important.
There are five common contract risks:
- Performance violations
- auto-renewal of bad contracts
- Maverick transactions
- Unapproved contracts
- Compliance failures
When the counterparty or your organization does not fulfill a material term of the contract there is a performance violation. One party must undertake certain action (or refrain from it) and fails to meet the requirement.
auto-renewal of bad contracts
Your organization’s view of a particular contract can sour over time. In that case, a once promising contract becomes a liability. Without careful attention to the renewal provisions, procedures and dates, the bad contract can renew automatically.
Contracts often create a framework for parties to conduct business over many transactions even though prices and terms might vary over time. In this case, the contract imposes upper and lower bounds on transactions so that the parties understand their maximum exposure under the contract.
However, maverick transactions occur when an individual in one organization completes a transaction outside those bounds. A maverick transaction can be intentional or unintentional. Without careful monitoring of the bounds, maverick transactions can accumulate and threaten the organization.
An unapproved contract typically occurs when an employee with apparent authority to execute a contract does so with a counterparty. A sound approval process and tracking mechanism can mitigate this risk.
When it comes to compliance, parties often focus on the counterparty rather than their own conduct. It is natural to assume that your organization would comply with a contract and want to watch the other party carefully. However, breaches happen, even unintentionally, if important provisions are not monitored for compliance by both parties.