Lawyers know the law, managers know how to make business decisions. Often, managers complain about the typical lawyers’ answer “it depends”. On the other hand, lawyers may suffer from the fact that they are sometimes called in the last minute of a negotiation to review the legal aspects of a deal; or even worse: if their legal assessment on the project is feared (“no”), they may even be avoided. How can both positions be reconciled? This is where contractual risk management comes in handy.
Contracts are a tool used every day by companies and individuals. If a contract is validly entered into, it binds the parties to the contract and creates obligations. If a party does not comply with the contract, it may also give rise to a claim for the compliant party. If a party is harmed in the course of performance of the contract, the other party may be held liable for the damage.
These risks of losses or unwanted outcomes can be minimized or avoided by consciously managing the legal risk linked to every contract.
In this article, we will provide you with a brief and simplified overview of contractual risk management. In our next blog-articles, we will analyze several of the material issues and critical clauses in more detail.
Because of the very high of number of contracts which are entered into by a company, the less risky contracts are often not reviewed by lawyers. This is already a decision based on risk management: in this case, the company does not want to allocate resources for either low risk contracts or low value contracts.
When the risk or the potential damage is high enough, it is recommended to ask the in-house counsel or an external lawyer to help in drafting, negotiating and finalizing the contract.
A company should have a procedure in place for contractual risk management:
- In particular, it must be communicated and known who is entitled to negotiate and sign contracts on behalf of the company depending on the value of the contract and the potential risks the company is facing. By doing so, the managers at the appropriate level (or even directors) make a conscious decision and are informed about the high risks or high value and are thus likewise informed regarding the exposure of the company.
- Moreover, it has to be determined if and at what stage a contract has to be reviewed by the legal department or an external lawyer.
- Contracts which are not reviewed prior to signing should be drafted based on templates which have been approved either by the legal department or an external lawyer.
2. While drafting/negotiating
The manager in charge must know and communicate what risk the company is willing to accept. On the other hand, the lawyer must clearly advise on how to minimize – if possible to avoid – the risk.
As a first measure, the lawyer in charge has to determine and respectively identify which law applies to the contract and the jurisdiction under which the parties will have to initiate litigation proceedings in case of a dispute. The parties may also choose to submit their dispute to arbitration instead. In this context, the question of the validity of any choice of law has to be assessed. The same applies to the validity of the choice of jurisdiction or arbitration. If the contract is submitted to the jurisdiction of another country, it is recommended to ask a lawyer of said jurisdiction to review the contract as well before signing.
In a second step, it has to be ensured that the parties can validly agree on the contract and its content.
From a historical perspective, Swiss law is liberal in terms of contract: Swiss law recognizes the principle of contractual freedom which means that the parties are free to enter into a contract, to choose the counterparty and to choose the content of the contract. Of course, the principle of contractual freedom is limited in many ways: a three year-old child cannot enter into a contract, the contract cannot have an illegal content, etc.
Under Swiss law, a contract is validly entered into when:
- The parties have the legal capacity to enter into a contract.
- The offer matches the acceptance.
- The essential and characteristic elements of the contract are defined or definable.
- The contract meets the formal legal or contractual requirements (e.g. in writing, notarized, etc.).
- The content of the contract is not impossible, unlawful or immoral.
- If one party is weak and inexperienced; there is no clear discrepancy between performance and consideration as a result of the exploitation of this party’s weakness.
- The parties were not under a fundamental error when entering into the contract.
- The contract has not been entered into by fraud or under duress.
Not meeting a prerequisite leads to the risk that the contract is void or voidable.
Beside the issue of the validity of the contract, numerous questions have to be negotiated, determined or clarified, such as:
- Language of the contract.
- Regulatory requirements.
- Indemnification/hold-harmless clause.
- Limitation of liability.
- Remedies in case of a breach of contract
- Security agreements (collateral, guarantee, etc.) and insurance requirement, which remain valid despite the potential insolvency of the counterparty.
- Clause on the assignability of the contract and/or of the obligations or claims.
- Change of control clause.
- Duration and termination of the contract.
- Possibilities to amend the contract subsequently.
3. After signing
Once the contract is negotiated and entered into, it is recommended to store the contract at the same place as the other contracts. It is also recommended to list all contracts the company has entered into. Finally, contracts shall be reviewed on a pre-defined frequency in order to assess the performance of the contract and identify in an early stage any risk that arose after concluding the contract.