Managing risks through the contract

The role of a contract is to set out the roles, rights and obligations of both parties in a transaction
or relationship. For the purposes of the management of contract performance, a contract is
basically a statement of:
 Exactly what two or more parties have agreed to do or exchange (specifications, prices,
delivery and payment dates and so on)
 Conditions and contingencies which may alter the arrangement (eg circumstances under
which it would not be reasonable to enforce certain terms, or agreement that if party A
does x, then party B may do y)
 The rights of each party if the other fails to do what it has agreed to do ('remedies' for
'breach of contract')
 How responsibility or 'liability' will be apportioned in the event of problems (eg who
pays for damage or loss of goods)
 How any disputes will be resolved (eg by arbitration).
Contract terms are statements by the parties to the contract as to what they understand their rights
and obligations to be under the contract. They define the content of the 'offer' (or counter-offer)
which becomes binding once accepted by the other party.
There are a number of important distinctions in regard to types of contract terms.
 Express terms (which are explicitly inserted into a contract by either or both of the
parties) and implied terms (which are automatically assumed to be part of a contract, by
virtue of relevant statute, custom or business and other factors).
 Implied terms, such as those implied in the UK by the Sale of Goods Act 1979, are
designed primarily to protect the buyer from basic risks, such as relying on descriptions
or samples of goods in making the purchase decision: in such circumstances, it is implied
that the goods supplied should conform to the description or sample. Similarly, it is
implied that goods supplied should be of satisfactory quality and fit for purpose.
 Many of the terms most important in the management of contractual risk are express
terms. The most common examples would be where the parties specify price, delivery
dates, how carriage and insurance costs will be shared, and so on. Another example is an
exclusion or exemption clause, which states that one party will not be liable (or will have
 only limited liability) for some specific breach of contract, or a force majeure clause
which specifies special circumstances in which a party will not be liable for failure to
fulfil its contract obligations.
 Conditions (vital terms of the contract, the breach of which entitles the wronged party to
cancel or 'repudiate' the contract) and warranties (non-vital terms of the contract, the
breach of which only entitles the wronged party to damages, with the mutual obligations
of the contract otherwise remaining in place). This is an important distinction in
managing the risk of non-performance or breach of contract.
Caveat emptor
The common law principle caveat emptor (Latin for 'let the buyer beware') states that a buyer
cannot claim damages for defects which make goods or services unfit for ordinary purposes,
unless the seller has actively concealed these defects. In other words, the buyer must take
responsibility for inspecting and choosing wisely before entering into contracts.
Now, under implied statutory terms in regard to 'satisfactory quality and fitness for purpose', the
buyer ; much better protected - but he still has responsibility to do due diligence, and make
reasonable investigations, inspections and choices.
Contract development and risk management
For a broad - non-technical - overview of how contracts can be used to minimise or mitigate a
range of supply risks, Table 11.1 sets out some typical procurement-related risks, and how
contract provisions might be used to mitigate them.
Passing of risk in contract
Risk generally (or prima facie - 'unless proved otherwise') passes with property or title in the
goods, but this may not always be the case. The passing of risk determines who is responsible for
insuring the goods, and who bears the cost of any loss or damage to the goods.
This is particularly important in international contracts, where delivery is likely to comprise
several stages, and goods are in the hands of various parties along the way. Who is responsible
for insurance and loss at each step along the way? The standard terms for international
commercial contracts - Incoterms 2010 -provide expressly for risk to pass at a number of
different stages in the journey from the supplier to the buyer.
Remedies for contract failure
Many contractual terms are designed to minimise risk by clarifying expectations and obligations,
and acting as a disincentive to non-performance, by providing for legal 'remedies' (redress) for
the injured party. However, there will inevitably be cases when a party is unwilling or unable to
perform all of its obligations under the contract, and in such cases the resulting damage or loss to
the injured party must be provided for by legal remedies for breach of contract.
Breach of contract is an unjustified failure to perform all the terms of the contract. There are
various remedies for breach of contract, depending on whether the breach is actual or
anticipatory (a party shows an intention not to perform the contract), and whether a condition or
warranty has been breached.
In appropriate cases, the party who has suffered a breach of contract may have any of the
following 'remedies' in law.
 Damages: financial compensation for losses suffered as a result of the breach. Where the
amount of damages is stipulated in the contract, as a genuine estimate of the amount of the
injured party's loss, this is referred to as 'liquidated damages'. If no amount of liquidated
damages is stated, the issue of compensation will be referred to the courts, which will decide
whether to pay 'unliquidated damages', and in what amount.
 Specific performance: a remedy whereby the court orders the defendant to carry out his
obligations under the contract, if damages would not be an adequate remedy (eg if the
claimant wanted to buy a particular property)
 Injunction: a remedy whereby the court orders a person to do something (mandatory
injunction) or not to do something (prohibitory injunction), in order to avoid a breach of
contract. An example may be an injunction restraining a supplier from breaking an
exclusivity contract. • Quantum meruit: a remedy available when a contract has been
partly performed, entitling a party which has provided a benefit, or performed work, to be
paid a fair amount for it.
Contract management and risk management
It is important to bear in mind that the legal aspects are not the only factor in identifying non-
performance of a contract. The buyer (or contract manager) will also have to monitor and
interpret a range of financial, technical and performance data to establish whether a supplier is
complying - or likely to comply - with price, time, quality and other express and implied terms;
whether the goods delivered conform to specification; whether services comply with agreed
service levels and so on. These are key aspects of project management, contract management,
supplier management and supplier performance management: all important aspects of risk
management in their own right.
Liability, indemnity and assurance
Liability
Liability, in a legal context, is in essence the legal and financial responsibility or obligation of an
entity in a situation. Organisations are 'liable' for debts, in the sense of having a legal obligation
to pay. They may also be 'liable' to pay compensation or damages to other persons or entities
who suffer loss as a result c their actions, under legal concepts such as the tort (common law
'wrong') of negligence and damages for breach of contract.
 Strict liability is a situation in which an entity is legally responsible for the damage or
loss caused by acts or omissions - regardless of fault (such as malicious intent or
negligence). The law imputes strict liability to situations it considers inherently
dangerous, in order to encourage entities to take a possible precautions. Strict liability
exists in product liability, for example: manufacturers, distribute suppliers, retailers and
others who make products available to the public are held responsible for an injuries they
cause.
 Vicarious liability is a situation in which a superior bears responsibility for the acts of
the subordinate organisations are generally liable for the conduct of their employees, in
the course of their work.
Litigation risk
Sadgrove cites an AXA survey which found that the biggest perceived threat to small and
medium-sized businesses (SMEs) arises from increasing litigation: the threat of being sued for
compensation, stimulated by the rise in 'no-win, no-fee' legal services. 'More businesses will be
damaged by mundane risks such as fire or lack of sales than litigation. Nevertheless, businesses
are right to be concerned and should take steps to prevent it.'
Indemnity clauses
An indemnity clause is designed to secure an undertaking from the other party that it will accept
liability for any loss arising from events in performance of the contract, and will make good the
loss to the injured party or parties. In other words, it assigns primary liability to the other party in
the contract.
Intellectual property rights (IPR)
Businesses often expend considerable time and money developing ideas, processes, designs and
other intangible assets that will enable them to generate profits. Once they have done so, they are
naturally concerned to ensure that they reap the benefits without disturbance from others. The
law assists them in this by providing a range of measures to protect such 'intellectual property'.
These laws derive from both common law and statute (especially the Copyright, Designs and
Patents Act 1988).
Various legal provisions are made for the ownership and protection of intellectual property
rights.
 Technological inventions may be protected by the law relating to patents (such as the Patents
Act 2004). To secure protection for an invention, the owner applies to the Intellectual
Property Office for the award and registration of a patent, which lasts for 20 years. The right
given by the patent is that of control over the use and commercial exploitation of the
invention (including granting usage licences to other parties). If a patent is infringed, a civil
action may be brought to seek an injunction to prevent further abuse, as well as damages or
an account of profits.
 Products carrying a distinctive design (shape, pattern or ornament) may be protected by the
law relating to registered designs. Designs may be registered at the UK Intellectual Property
Office, and protected for five years (extendable in five-year periods to a maximum of 25
years). An automatic 'unregistered design right' in any case applies for 10 years from the
article's first marketing or 15 years from its first design - whichever period expires sooner.
During the last five years of this period, anyone may obtain a licence to make the article by
paying a royalty to the owner. If any design right is infringed, the remedies are an injunction,
plus damages or an account of profits.
 The goodwill attaching to a particular mark or logo used by a business may be protected by
the law of trademarks and service marks (Trade Marks Act 1994). In the case of abuse of an
unregistered mark, the main recourse for the owner is to bring an action for the common law
offence (tort) of 'passing off': deceiving the public by deliberately causing confusion with
another (better known) brand or organisation. A registered trade mark (one formally
registered with the Registrar) is protected against use of any 'similar' mark on goods or
services 'similar' to those covered by the registered mark (causing the possibility of public
confusion).
 Protection of original literary, dramatic, musical and artistic work (including graphic work
and computer programmes) is afforded by the law of copyright (Copyright, Designs and
Patents Act 1988). The right to protection arises automatically and expires 70 years from the
end of the calendar year in which the author (or other assigned owner) dies. Infringement of
copyright usually means that someone has copied or adapted a work created by someone
else.