How Much Deal Risk Can You Tolerate?

I concluded my recent post on “good enough” in contract drafting by distinguishing the quality trade-offs inherent in the notion of “good enough” from the question of how risk-averse you want to be in drafting and negotiating deal terms.

But those issues are related, in that both require you to determine when you reach the point of diminishing returns in allocating resources. In the case of “good enough,” the question is how rigorous in language and substance you want your contract to be, the aim being to enhance clarity and avoid confusion. In the case of risk, the question is whether the protection afforded by covering yourself against a given risk outweighs its drag on competitiveness.

In my “good enough” post I suggested that whereas we may be in a “good enough” world when it comes to technology, that phenomenon is nowhere in evidence in the dysfunction that is mainstream contract drafting. Far from making a calculated decision to sacrific a measure of quality, to all appearances drafters aim to be comprehensive and clear and remain largely oblivious of the extent to which they fall short.

Similarly, drafters could in theory embrace a less risk-averse approach when setting deal terms, with the idea that since much risk only materializes in a small proportion of deals, or doesn’t materialize at all, it doesn’t make sense to burden all deals by protecting against even the more remote risks. But I’ve seen little sign of such a tolerance of risk. In fact, in this post on his Commitment Matters blog, Tim Cummins of the International Association for Contract and Commercial Management notes that a desire to manage risk has contributed to increasing contract complexity. (Thanks to Vickie Pynchon of the Settle It Now Negotiation Blog for sending me a link to Tim’s post.)

The obstacle to a more nuanced assessment of risk in contract drafting is analogous to what makes “good enough” problematic in the context of legal services. It’s all well and good to observe that much risk never materializes, but when you’re working on a new transaction, you’re dealing with the unknown—this might be the deal where a remote-seeming risk materializes. And it’s easy to tell yourself that adding some verbiage to a given set of deal documents is a small price to pay for protecting yourself against potentially disastrous risk—the deleterious effects of undue fear of risk are manifest over the long hual, rather than on a deal-by-deal basis.

There’s no way to get around the fact that you can’t see into the future. But you’re nevertheless going to make some sort of risk assessment—otherwise, you’d document every transaction as if the future of your company were at stake. It would be best if, instead of being handled on an ad hoc, deal-by-deal basis, your assessment of risk and the extent to which you wish to protect against it were based on a clear-eye, big-picture analysis of the costs and benefits.

But talking about risk in the abstract only gets you so far, so here’s a practical suggestion. You won’t be able to handle risk efficiently if you uncritically buy into the conventional wisdom regarding risk-allocation provisions—for example, if you trot out the standard language relating to consequential damages (see this March 2010 blog post), or if you think that it does anyone any good to suggest that best efforts represents a higher standard than reasonable efforts (see this March 2009 blog post).

It’s also tough to handle risk efficiently is you’re employing the clumsy legalese of mainstream drafting—it’s like trying to do dentistry with a rusty screwdriver.

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.