Business Law Today contains an article entitled Data, Contracts, and Making Hard Decisions—Changing the Way We Manage Risk. It’s by Jamie May, associate general counsel at University Hospitals in Cleveland, Ohio. I had the pleasure of meeting Jamie a few years ago, when he wore a different hat, and I’ve corresponded with him sporadically.
Here’s the first paragraph of Jamie’s article:
Contracts are a ubiquitous feature of modern business, and their value is rarely questioned. The proliferation of contract-management teams, commercial attorneys, and a dizzying array of contract-related software tools are testaments to our devotion to contracts. As cost and resource pressures on in-house business lawyers rise, it is time to rethink this devotion and to spend more time and money on more robust risk-assessment and risk-management strategies.
Jamie’s thesis is incontrovertible: assessing risk better could allow companies to simplify some of their contracts and eliminate others entirely. So read the article!
But while I’m at it, something in the article caught my eye. After noting that contracts professionals spend much of their time in negotiation theater (my terminology) and that traditional contract drafting is a hot mess (my terminology), Jamie says this:
One solution is to wait until a critical mass of lawyers adopts a rigorous set of contract-drafting parameters (such as Adams’s A Manual of Style for Contract Drafting). Given the nature of lawyers and the history of our profession, I am not holding my breath. A better way is to systemically reduce the importance businesses assign to contracts in favor of robust risk assessments and pragmatic risk-management strategies.
Two thoughts come to mind:
First, I’m not sure that “better way” is the, uh, best way to express the comparison Jamie offers. Modern contract drafting is about making sure that your contracts are clear, concise, and avoid the unnecessary risk that comes from uncertain meaning. By contrast, risk management is about assessing external risk and determining whether to address it in a contract, and if so, how. There would seem to be little overlap between the two, so it’s not an either-or choice—you should do both.
And second, I think that of the two challenges, clear contract drafting is actually easier to achieve. For one thing, one of the saving graces of contract drafting is that it’s not subject to popular vote. The only people you have to convince of the value of clear drafting is the people on your side of the table and the people on the other side of the table. And if you’re sensible and enlist expert help and automate your drafting using Contract Express or something comparable (if deal volume, deal value, and deal customization warrant it), you can quickly implement clear and tamper-proof templates. By contrast, risk assessment seems like something of a black art.
Jamie’s article is the second of three. Go here for the first one; I look forward to the third.
8 thoughts on “Reducing the Burden of Contracts Through Risk Management”
Both of these articles are excellent. Thanks for the pointers. I especially agree with his point on indemnities — in most commercial deals, they are unnecessary and you can address the same risks more easily by way of a promise.
Interesting and provocative. Ken’s observations about the second article are sound, though I wonder how you can do a proper risk assessment in the absence of an enforceable contractual obligation (creditworthiness and reliability analyses are usually keyed to the contract obligations being assumed).
I do have a couple of niggling doubts about May’s first article. With respect to indemnification clauses, he posits that it’s better to say that a party should assure that no third-party claims are brought; but since the party has no control over those claims, saying that is exactly the same as an indemnity, or, in the words of the MSCD, “[party] will be liable for…”
Second, on insurance, I think May is creating a straw man when talking about creditworthiness. It’s not the creditworthiness of the insurance company, as compared to that of the insured, that matters, it’s its pure bulk. A triple-A rated company with assets of $10 million cannot cope with a $20 million liability, whereas even Fred’s Insurance and Storm Door Company, a division of Nocturnal Aviation, with assets of $5 billion and a Best rating south of A+, can cope, even if Eric Schneiderman is breathing down its neck. Where May is right on target with respect to insurance is in pointing out that most contract claims will have nothing to do with whatever insurance a company has (with the exception of E&O insurance for certain classes of service providers).
Let’s flip it around. When is an insurance provision appropriate? My key example is when a large company is hiring a small company to do something, and the small company probably can’t withstand multi-million dollar judgment. In those cases, there are often two motives: (1) make sure that claimants have some deep pocket to go after other than the large company and (2) protect their own supply chains from disruption. But to Jamie’s point, this is a risk assessment!
If you all are in an insurance frame of mind, remember this: https://ipdraughts.wordpress.com/2015/08/08/insurance-obligations-in-commercial-contracts/.
Yes, of course it’s a risk assessment, as in effect are all the other points reflected in the clauses under discussion. It’s a fairly easy assessment to make when the parties are in the relationships you describe, and I don’t often see elaborate insurance clauses in many other types of situation. Leases are another situation where an insurance clause is de rigueur, and there are good reasons for argy-bargy over those clauses as well.
Thanks for the comments, guys. And thanks to Ken for linking the articles to his blog. Both of your examples are good ones, but in either case, unless the insured’s policy covers the loss, insurance is meaningless. And, inevitably, the facts of an actual loss are always different from those anticipated. Also, while I’ve asked to see a counterparty’s insurance policy many times, I’ve never been allowed to do that. Even if the policy covered the loss, are our colleagues in risk management following up with the counterparty to make sure they’re paying their premiums? Vance, you’re right that creditworthiness is less important than the available, liquid reserves of the counterparty. Unfortunately, I don’t know of a tool to evaluate that for non-publicly traded companies (like Dunn and Bradstreet works for credit quality).
Typically, a provision on this topic requires the contractual counter-party to provide a certificate of insurance that includes a 30-day notice before the insurer cancels or non-renews the insurance for any reason (including non-payment of premia). Large companies that use lots of small vendors are very on top of this and immediately stop sending new work to vendors whose insurance lapses without a new certificate.
One of the greatest challenges is
determining how much risk your organization is willing to incur across
the entire portfolio of agreements, and as you author and negotiate
individual agreements, and engage subject matter experts to review and
approve them. Process of Risk Management certainly varies by company, industry, corporate
philosophy, business model, and level of globalization.