Tips for managing your business contract risks

A legal audit is due diligence done on a business that helps it to ascertain and minimise legal risk it is exposed to through non-compliance to checks and controls. Any sound risk management strategy, policy or exercise ought to include recommendations drawn from such audit.

There are several potential pitfalls that I have come across while conducting a legal audit and they are serious enough to lead to closure, for example when a business is operating without regulatory approval.

One of the most common risks that I have come across, is contractual. In this column I highlight how your business can identify, manage and mitigate these. Unmanaged risk exposes your business to lawsuits and furthermore can cause huge losses.

One major contractual risk is that many enterprises do not have contracts in the first place, despite this being inevitable in today’s business environment. I came across several businesses which operate on a gentleman’s agreement or good faith in areas where they ought to have formal contracts. Enforcement becomes an uphill task without written contracts. There must be signed contracts for all operations as they set out the understanding between the parties such that there is clarity. For example, if it is a supply contract, there is clarity on the subject matter and when the supply should be done.

Where there is no contract there is bound to be a disagreement. Formal contracts also help manage dispute resolution in various ways. Firstly dispute-resolution clauses provide for the manner in which they should be handled. Secondly, a written contract constitutes documentary evidence which can be adduced to prove one’s case. The court is likely to interpret the parties’ rights and obligations as per the contractual provisions.

A second contractual risk I identified is lack of quality contracts. Some of the “contracts” I reviewed were nothing more than a memorandum of understanding which did not adequately set out the terms. Avoid drafting do-it-yourself contracts from the Internet. Most are irrelevant and unenforceable. My suggestion is to involve a lawyer as contracts are not just generic documents but specific to the parties’ needs.

The last risk I found was lack of enforcement. This occurred where parties have sound contracts but did not have proper enforcement mechanisms. There are several remedies for this. One is specific performance which is where one has the remedy to apply to court to order the breaching party to do what it promised to under the contract. For example, in a supply contract where one has supplied the goods but has not been paid, an order for specific performance would compel the breaching party to pay.

The second remedy is restitution which means restoring the aggrieved party to the position it was in before the breach occurred. Examples include refunding money that the aggrieved party spent to finance its own performance. Restitution compels the breaching party to refund the money spent.

The last common order is for general damages where the aggrieved party is awarded monetary compensation for breach of contract.

Sound contractual enforcement is crucial. Heightened contractual risk can lead to losses while the opposite can improve performance. A legal audit would help establish the adequacy of your contracts and advice on enforcement.