The importance of contractual risk management, with both suppliers and customers (up and down the chain) should not be underestimated. Understanding commonly problematic contractual clauses and risk exposures is vital for those with commercial responsibility. Without care, a business may be severely exposed financially. External assistance with the review of contracts should be sought where you do not maintain a competent legal department.

Liability insurance provides protection for a business against contractual and legal liability in the event of a fortuitous loss and is therefore an effective risk management tool. However, an insurance policy will typically not respond to losses where a contract extends beyond the operator’s legal liability. Such additional losses are often uninsured and would be met by the operator, stressing the necessity of sound contractual risk management processes. 

A recently published edition of the TT Club Risk Byte series focuses on the topic of contractual risk management, providing operators a useful tool to consider a variety of concepts, terms and risk mitigation strategies.

Assessing the contract

In TT’s experience, many customer businesses have developed template corporate contracts, typically containing onerous terms for the logistics operator. It is not uncommon for these corporate contracts to be biased towards general purchasing requirements, often not well suited to the specifics of logistics services. Such paucity of understanding of logistics complexities can lead to dysfunctional provisions, which may be extremely difficult to comply with, and result in unexpected losses.

Scrutinising contracts early in the negotiation stage is a vital step in mitigating contractual risk. It can be daunting to challenge a large customer, so developing an understanding of the most problematic clauses, why they exist and how they impact risk is essential. The Risk Byte guidance document empowers logistics operators to improve their management of the contractual risk.

Scrutinising contracts early in the negotiation stage is a vital step in mitigating contractual risk.

A balanced contract will provide a range of benefits to both parties. Clearly defining responsibilities will assist in avoiding commercially damaging and expensive disputes. A contract should provide certainty, defining a law and jurisdiction and limiting liability in the event of a loss. The terms of the contract should facilitate fair and prompt payment for services provided.

Are the terms too onerous?

It is clear to see how disputes can arise where a contract is signed containing onerous terms heavily in favour of the customer or is not appropriate for the services being provided. There may well be different incentives between functions of the same business, most commonly present where businesses are growing aggressively. For example, sales targets might drive consideration of contracts that are potentially outside of the comfort zone.

While a commercial decision, developing a sound understanding of the terms of the contract and the potential risk exposures is prudent. At the simplest level, can the operations department actually meet the demands of the contract? Could losses through the period of the contract exceed the financial reward? Having a joined up, cross-functional approach is essential to protect your business. 

Having a joined up cross-functional approach is essential to protect your business.

An example of inadequate appreciation of operational necessity in logistics might be that the customer seeks to disallow subcontracting. Even where subcontractors are allowed and used, operators should ensure that they contract on back-to-back terms providing a recovery option in the event of a loss under the contract. In practice, back-to-back means you are contracting with your subcontractor on the same terms as you have contracted with your customer, thus avoiding a gap in liability between what is legally owed to your customer and what is recoverable from your subcontractor.

Which clauses are key?

In the interests of providing certainty, while not exhaustive, there are a series of clauses that should be interrogated.

• Operators should avoid entering full and enhanced liability contracts. Such contracts expose your business to levels of liability beyond compulsorily applicable national laws or international conventions. Accepting such contracts may prejudice your liability insurance cover (unless your insurer has formally agreed the terms) and your sub-contractor may refuse to accept back-to-back terms.
• Liquidated damages (sometimes called punitive damages) are typically fixed contractual penalties for failure or delay in performing your services. This type of loss is unlikely to be recoverable from your liability insurance policy, so should be avoided.
• Avoid accepting indirect and consequential losses, such as loss of profit or delay, other than those directly related to loss or damage to a cargo. Failure to exclude indirect and consequential losses could expose you to an uninsured claim.
• The time bar provides a level of protection and assists in resolving disputes in a timely manner. A time bar of nine months to one year for commencing legal proceedings arising out of a claim against your business is likely to be considered fair, reasonable and enforceable in many jurisdictions.
• Ensure wherever practicable that you are comfortable and familiar with the law and jurisdiction clause. In a global business world, it is possible that your business and that of your customer are operating in two different jurisdictions so negotiations over which jurisdiction is applicable might be necessary. It can be both costly and uncertain to handle claims under restrictive, unfamiliar laws or before unsympathetic courts.

Summary

It would be prudent, particularly if your business does not benefit from a dedicated legal department, to develop an understanding of contractual risk management. Identifying the most important clauses, what they mean in the context of a loss or dispute and negotiating with your customer where appropriate. Speak with your liability insurer where onerous contracts are concerned providing opportunity to consider the contractual terms and exposures. Understanding the potential risk exposures will empower you to make sound commercial decisions.

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If you would like further information, or have any comments, please email us, or take this opportunity to forward to any others who you may feel would be interested.