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Contract risk can be caused or increased by a failure to appreciate the importance of good contracting or by an "any contract will work” attitude. After a contract risk has materialized and a loss has occurred, it might be too late to change your contractual rights and responsibilities. As stated by Louis M. Brown, "when you 'sign on the dotted line', you obligate yourself; before you sign, you have a freedom of choice not available later.”[1] As noted in Chapter 1, the proactive approach adopted in this book builds on and enables using contracting processes and documents proactively to (1) decrease the possibility and impact of negative events; (2) increase the possibility and impact of positive events; and (3) enable sound risk taking, which includes balancing risk with reward. in the following discussion, we call these the (1) preventive; (2) promotive; and (3) balancing power of contracts.

Contracts may lead to unexpected losses or other negative outcomes, such as misunderstandings, delays, claims, or disputes. if contracts fail, business performance will suffer. A lot is at stake, including goodwill and reputation. Contract disputes are expensive, in terms of money, management, and staff time that could be used for productive work. However, using the preventive power of contracts, unnecessary causes of problems can be eliminated and their negative impact can be minimized. in addition, contracts can be designed to provide procedures for handling problem situations and resolution mechanisms if delays or disturbances occur or if a conflict arises.

The pyramid diagram in Figure 2.2—borrowed from preventive law, which in turn borrowed it from preventive medicine— prompts us to think along three basic domains of prevention: first, prevent the cause from arising; second, prevent the cause from doing harm; and third, if harm occurs, limit the damage. This way of thinking leads us to develop strategies and tools to minimize friction and keep causes of risk and problems from arising (level one); to seek early intervention to prevent causes of risk from doing harm and problems from becoming disputes (level two); and to mitigate risk and resolve conflict to limit losses and expense (level three).

These measures are intertwined: as will be seen later in this book, contractual conflict prevention is not restricted to dispute resolution clauses alone. one of the most powerful ways to prevent and control disputes between contracting parties is to rationally allocate risks by assigning each potential risk to the party who is best able to manage, control or insure against the particular risk. Conversely, unrealistic shifting of risks to a party who is not equipped to handle the risk can increase costs, sow the seeds of disputes, create distrust and resentment, and establish adversarial relationships that can interfere with the success of the business enterprise.[2]

The three domains of prevention

Figure 2.2 The three domains of prevention 11

Using the promotive power of contracts increases the likelihood and impact of business success and helps identify, create, and maximize opportunities. If the focus in contracting is on realizing business benefits and on success (rather than failure, which is currently often the case), the promotive power of contracts can be used to its full potential. The likelihood of successful outcomes and business benefits can be enhanced when contract preparation and negotiation do not take too long and when they focus on effective implementation. In this way, unnecessary friction and misunderstandings can be avoided, resulting in faster order intake, earlier performance and cash flow, better business relationships, and reputational goodwill. optimally, these will lead to cost reductions, more benefits, and earlier benefits for both parties.

Apart from enabling the parties to reach their business objectives and prevent problems and disputes, contracts have one more capability that is important in the context of reaching business and legal objectives; using the balancing power of contracts, the parties can balance risk with reward. they can—and should—do so both in their own decision making and when considering the needs and interests of the other party. A supply contract, for example, should ensure that the supplied goods, services, or solutions will meet the buyer's requirements, while at the same time satisfying the supplier's needs and expectations relating to profitability and risk. In an ideal situation, the risks taken by the contracting parties are identified and reflected in the parties' roles and responsibilities as well as in the requirements, scope, price, schedule, and other terms. the balancing power of contracts is illustrated in Figure 2.3.

The balancing power of contracts

Figure 2.3 The balancing power of contracts

An ideal contract also balances the legal needs and business needs of the parties, including the need for predictability and flexibility. A contract should not limit the parties' ability to innovate in the future, nor should it involve unidentified requirements, responsibilities or remedies that reduce profits or other expected benefits or increase cost or risk. Here we are not talking about contract provisions that are accepted, with eyes wide open, as legitimate trade-offs. Rather, we are talking about unexpected, unfavorable terms that could have been avoided or mitigated by using thorough preparation, skillful negotiation, and the promotive, preventive, and balancing power of contracts.

As noted earlier, contracts seek to secure clarity and remove uncertainty as to business and legal objectives and how the parties plan to work together to reach those objectives. Contracts can help provide predictability. When the power of contracts is used at the early stages, the crafting of a contract becomes an important initial step in articulating the business plan, in thinking through potential contingencies that may affect it, and in achieving business objectives. Viewed in this way, contracts can help align expectations, encourage innovation, improve supply chain performance, provide adequate protection, and balance risks against rewards and benefits.

  • [1] Louis M. Brown, known as the Father of Preventive Law, in How to Negotiate aSuccessful Contract (1955) Englewood Cliffs, NJ: Prentice-Hall, inc., p. vii.
  • [2] See, for example, Groton, J.P. and Haapio, H. (2007) From Reaction to ProactiveAction: Dispute Prevention Processes in Business Agreements. International Association forContract and Commercial Management EMEA Academic Symposium, London, 9 October2007, available at 7 - FromReaction to Proactive Action - Dispute Prevention Processes in Business Agreements.pdf.
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