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
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.