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This article is written by Sankeit Tanejaa, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here he discusses “Risk Assessment of Contract”.

Introduction

Contracts altogether forms are surrounded and are available in various manner but most frequently take the shape of various agreements for instance consulting services agreements, licenses, memorandum of understanding, purchase orders, partnership agreements. Given the extensive range of such contracts involved, it’s obligatory for all concerned parties to be involved in the negotiation and execution of contracts to know the risks involved and use prudent control strategies to mitigate them.

Parties enter into contracts either verbally or written and are often used to establish, create or expand the connection between two or more parties and term the circumstances of how each will cooperate within a given set of circumstances. 

Explanation

Contractual Risks are anticipated to allocate obligations be it financial or otherwise for risk exposures to both the parties by one another. Contractual Risks can discharge the individual or association initially accountable for the risk by assigning it to one or more of the contract’s counterparties. In a contract, risk transfer is primarily arrived at through a combination of indemnification, limitation of liability, and waiver of subrogation clauses.  It is suggested that contracts be organised to assign obligations for risk to the party that creates it and is best placed to alleviate its impact.

Indemnification: Indemnification clause compels one party being the Indemnitor to reimburse the other party being the indemnitee for the loss, damage, injuries, harm caused to him by the Indemnitor. This clause helps in mitigating risk and is closely tied to representation and warranties, which promises that specific things are done in a specific manner. 

Waiver: A waiver clause is one wherein a party voluntarily surrenders its right. Through the presence of waiver clause, it ensured that a party does not accidentally or informingly waive its right in order to bring proceedings and recover damages in case of breach of contract by the other party. 

If a risk has been identified, the next step should be the assessment of the risk so discovered and to evaluate its impact on your organisation financially and otherwise.  There are 2 factors which should be considered while assessing risk i.e. its Probability and its Consequences.  Taking an example for instance, Consequences of entering in an agreement or contract would be high in the initial period but shall gradually diminish once the potentials of an agreement or contract are pointed out and ample time is spent over those potentials.  

Another important factor apart from Probability and Consequences is Risk Thresholds and how to discover these Thresholds for your organisation. Risk is an element which is present in every binding legal agreement or contract, but it is important to know how much risk is one willing to take either person in case of a private contract or risk which their organisation shall take while entering in a contract. After establishing risk of a contract or agreement, an individual or an organisation can decide if they wish to enter into such a contract or agreement depending if the risk is beyond or within their tolerance level. 

A contract comes with opportunities as well as risks, hence contract management must have data analysis and prevention of risk. Without measures placed to identify and monitor contract risk, organisations will have to deal with disadvantages which would lead them to deal with extra costs which might lead to violations of various compliances and unwanted litigations. 

A Risk Assessment is done to determine possible disasters, catastrophes and other unwanted situations Risk Assessment is a vital measure of risk management strategy which leads to the introduction of controlled processes to eradicate or diminish any probable risk-related concerns.

Risk Assessment may be different at an individual level than at an organisational level. At an individual level a simple process of recognizing aims and risks, observing its importance and forming tactics may just be sufficient to eradicate risk. But at an organisational level, more elaborate policies pointing out acceptable levels of risks, procedures thereby to be followed by the organisation and the allocation to its resources matters. 

Establishment of Context is an important step in assessing risk as it curbs the range of perils. Risk assessment comes into the picture when there is valuation of risk. Now while evaluating risk, when mitigation and other alternative solutions are considered, it is known as Risk Assessment.  Based on risk assessment, risk is controlled. This process in depth is called Risk Management. 

Organisations can assess risks better if they have a risk assessment strategy. Having a risk assessment strategy shall help organisations to remain assertive while remaining compliant. Organisations can use various strategies to avoid unsolicited risk such as:

  • Capitalize in smart contract management software.
  • Focus on particular words, clauses and situations which a particular organisation deems as risk to alert users of sensitive data.
  • Usage of smart tools within contract management software to analyse contract data and assess any risk related with each contract.

Purpose of Risk Assessment

Risk assessment in contracts is required for the purpose of reducing the potential risk or threat which the parties to the contract might have to face and to help the parties to the contract handle the risk in a better and thorough manner.

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Elements to avoid risks in Contracts

The following elements must be present or if not present be created to adhere risk in contracts to a minimal level:

Establishment of Transparency– Any word which creates confusion or vagueness to a particular section, clause or part of contract must be avoided. Absence of Transparency leads to errors.  

Simultaneous Reviewing of Contract– A contract should be reviewed a numerous number of times before its execution. A review begins when misunderstanding in contract or any part of it is being cleared. Once review has begun, it tends to clarify the misunderstandings which arise due to absence of transparency. A review is done so as to keep all parties to a contract on the same page. The continuous review brings out clarity to the negotiation process.

Qualify Risk Transfer: When risk transfer is considered, loss and how loss is insured is taken into consideration. Harvard University recommends to transfer risk in a few ways which are as follows:

  • Monetarily: To equalize responsibilities.
  • Indemnity Terms: Negotiate these terms which a person holds, harmlessly without any legal consequences. 
  • Liability Terms: Protects an organisation from risk with soundness of liability. 

Risk Neutralization: A risk shall neutralise when a contract as a whole is fair, convenient and performable to all parties to a contract. Risk Neutralisation is the end result of all the above mentioned clauses.

Case Law: Herbert vs HH Law

The case was pronounced by Justice Hoole in the Sheffield District Registry of High Court on 21st March 2018. The decision laid by the District Judge Bellamy was set aside. Ms Herbert being the Claimant/Respondent claimed damages for personal injuries caused to her along with substantial loss suffered by her due to road accident in 2015. Her vehicle was hit by a bus from behind. She entered into a Confidential Fee Agreement which stated that “if the claim is successful, she would pay HH law all basic charges, disbursements, success fee.” The agreement also stated that “if the success fee was set at maximum 100% but subjected to maximum 25% of the total amount of damages for pain suffering loss of amenity & damages for financial loss caused to her in the past due to the accident.” 

When the matter first reached before Justice Ballamy, he made the following decisions that while assessing HH Law’s bill of cost with respect to Ms Herbert’s claim of personal injury, Justice Ballamy, reduced the success fee as mentioned under the Confidential Fee Agreement from 100% to 15%. Secondly, Justice Ballamy approved of cash payment in terms which treated payment of Ms Herbert’s Insurance premium as Solicitor’s disbursement. Lastly, Justice Ballamy declined to inquire further into the contentions of HH Law’s contention Herbert’s new attorney being JG Solicitors Ltd (JG) was filled with illegality and was unenforceable.

When the matter reached Justice Hoole in the Sheffield District Registry of High Court, he upheld the decisions made by Justice Ballamy for the reason being that the approval must be informed & HH law had not done enough to achieve the approval of Ms Herbert and thereby dismissed the notion that the requirement of approval was restricted to cases where client has been deluded by their counsel. Justice Hoole also upheld Justice Ballamy’s decision to reduce the success fee mentioned under the Confidential Fee Agreement to 15%.

Justice Hoole further held that the decision made by Justice Ballamy was not erred in any way whatsoever and thereby directed HH law to take up the matter with SRA as it fell within their ambit. 

The above case clearly points out the importance of assessing risk in a contract before a person enters into it. Even the smallest of the smallest vagueness or disagreement can lead to chaos and thereby result in a high-risk rate.

Takeaways

Knowing how to assess risk is an important step in a risk management strategy. Once the risk has been identified, one should understand the probability and its consequence, apply the score and then determine risk thresholds which are acceptable. Risk can also be assessed by clear readings of contracts which is the very first and basic step towards assessing risk.  


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