Using Risk Scores to Empower Faster Contracting

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The Holy Grail of the contracting world is achieving faster cycle times. But no good deed goes unpunished: If you get a cycle time reduced by 10 percent, the next quarter you will be asked to reduce it by 25 percent. But the constantly lurking question is: when is speed outweighed by risk and sacrificing quality?”

But this is often not the right question to be weighing. Rather, the right question is: “How do we quickly quantify the risk allowing for an informed decision within the parameters of an agreed upon contractual risk profile?”

If you’re in the business of negotiating contracts, you most likely have been a part of an internal discussion related to cycle times and how to shorten them. Getting the business side and risk side to sit down and talk about an acceptable middle ground is often harder than it should be.

Part of the issue is sometimes being able to speak a common language. And as is the case for any negotiations, the sides may take a position and dig in. Whatever the issue is, a middle ground can only be found if the two parties are willing to lay the foundation of what “acceptable” risks are for their business. This must start with each stakeholder first identifying its own appetite for risk.

The idea of identifying “acceptable” risk isn’t a novel one. Fallback provisions and contracting playbooks have been around for a long time. These playbooks identify acceptable changes or risks for specific clauses or sections of a contract. They lay the groundwork for taking a holistic view of contractual risk.

What if you valued each clause and each fallback clause with a weighted risk score? Then you could add up the score of the contract to determine if it needed any deviation approvals. The lower the score, the better the contract. For instance, a contract with a score under “x” wouldn’t need any review and a score of “y” would only require a few approvals – and only in a few extreme circumstances would a senior level approval be needed. You could then take this a step further and consider the risk weighting based on complexity of the contracted scope and type of financial model.

This type of holistic contract risk view would require a meeting of the minds between Legal, Finance, the project team, and others. Not every function or business views risk the same. For example, payment terms are not as impactful for some businesses as they are for others – especially when comparing the risk mitigation objectives of buyer and sellers. If you are seller in a project-based business that requires heavy initial investment to perform a service for a customer, the buyer insisting on 100% payment terms upon final delivery may result in financial cash flow that is unacceptable to you. Your business team would want a high score placed on payment terms that did not deliver cash on signing and at various milestones during the project. The Legal team would most likely want to give traditional high risk clauses correlating high point values – if they are deviated from their standard position.

"The reality is that a lot of small changes can take a large amount of effort and have minimal effect on the overall risk profile. This is not just effort by the contracting team, but also by all the various stakeholders engaged to approve a deviation."

With a more holistic approach, the contract can be reviewed, scored, and identified as an aggregated “acceptable risk,” and signed without engaging the time of all the various stakeholders. Taking a data- driven approach, a business may realize they have a large percentage of contracts that would be considered “acceptable - no approvals required,” which would save time for the deviation approvers, the contracting team, and allow for a more rapid negotiation and quicker start to their business relationships.

Use of a risk-scoring approach by a business allows it to rapidly identify acceptable risk and empowers your negotiators to proceed with a clear understanding of what is truly a risk to their business, and to assess the impact of their decisions on the overall risk value of the transaction. This approach will lead to fewer internal approvals needed, a leaner contracting process and, ideally, happier business partners.