Contracts are the foundation of every business relationship. They define the rights and obligations of the parties involved and thus create the necessary security for successful cooperation. Thanks to the freedom of contract, the provisions in contracts can largely be freely drafted as long as they are not immoral (i.e. in line with the prevailing legal and social morals). However, precisely because contracts are so important and there is less protection for the parties involved in the B2B sector, they harbor considerable contractual risks. A poorly drafted contract or overlooking critical clauses can have serious consequences - from financial losses to legal disputes, as the following example shows:
Supply chains today are often affected by delays. One particular incident in the Suez Canal affected the movement of goods worldwide. Ships had to wait for days because the canal was blocked. Some shipping companies chose alternative routes or sent some of the freight by air. This resulted in additional costs, such as for personnel, storage or spare parts.
Although delivery delays are normal, the one-week blockade led to a large backlog that was still noticeable weeks later. According to § 280 and § 286 BGB, the customer is still entitled to the delivery despite the delay. In addition, he can demand compensation for the costs incurred, such as for loss of production or more expensive replacement purchases. The supplier does not have to have caused the damage directly, but it is still responsible for it because the delay is the cause.
However, the incident in the Suez Canal could be classified as "force majeure" as it was unforeseeable. In such cases, it is often unclear whether the usual regulations on delay apply or special force majeure clauses that can limit the supplier's liability. The decisive factor is whether the incident actually counts as force majeure and to what extent the clauses apply. More on this in the following article.
As a result, contracts are essential, but they must be negotiated and drafted carefully to avoid unpleasant surprises. In this article, you will find out what contractual risks can lurk in contracts and what you should pay particular attention to in order to make your business relationships secure.
Contract risks go far beyond the obvious and can jeopardize your company in many ways. In addition to financial losses due to contractual penalties or unfavorable payment terms, there are also legal, security-related and reputational risks that are often underestimated.
Financial risks are often the first thing that comes to mind when you think of contract risks. These can arise fromautomatic contract extensions, missed deadlines or failed milestones, which can lead to significant losses. Companies risk not only immediate financial losses, but also long-term burdens.
Legal risks arise when contracts contain unclear or ambiguous clauses. In particular, these risks include breaches of contract, which can occur if certain contractual terms are not complied with and lead to contractual penalties or claims for damages . In addition, such ambiguities can lead to legal disputes that require considerable time and resources. Contracts with unclear provisions on intellectual property or confidentiality are particularly critical, as there is a risk of not only financial losses but also lengthy and cost-intensive legal proceedings.
A software company licenses its data analysis software with the agreement that it will only be used for internal purposes. As the contract does not clearly define what "internal purposes" means, the partner integrates the software into a commercial product and sells it on. The licensor claims damages for this breach of contract, which leads to a lengthy and costly legal dispute.
A damaged reputation can have a direct impact on your company's financial performance. Negative headlines resulting from contract disputes or security breaches can destroy customer confidence and lead to a decline in market share. A bad reputation is difficult to repair and can have long-term effects on a brand.
A construction company and a real estate developer issue a joint press release falsely touting high-quality building materials for a project based on incorrect contract information. When the truth comes out, both companies are criticized for their lack of due diligence in reviewing the contract. The incident damages their reputation and leads to a loss of trust among customers and investors, which may affect future business.
Operational risks often arise from inefficient contract management processes. Incorrect data entry, such as incorrect prices or incomplete contract details, can lead to significant problems if they are not recognized before the contract is signed. Gaps in communication between departments, for example if special conditions such as discounts or additional delivery quantities are not passed on correctly, can also lead to misunderstandings. To avoid breaches of contract, a company then has to produce more at short notice, for example, which can lead to overtime, machine overload, delays and increased operating costs.
A further risk arises from agreements that bind the company exclusively to one partner, e.g. a supplier. In such cases, the company can become heavily dependent on a single source. If this supplier fails or increases its prices, the company lacks the flexibility to react to these changes, which can lead to challenges such as production delays, delivery bottlenecks or increased costs.
Finally, special conditions stipulated in the contract must be carefully checked for compliance with legal regulations in order to avoid legal consequences. Contracts that violate labor or environmental protection regulations can result in fines and legal disputes , which not only cause financial burdens but can also lead to business interruptions or production stoppages.
Overall, it is clear that contractual risks can occur in various areas and affect your company in a variety of ways. Careful contract review and awareness of potential risks are therefore essential to avoid long-term damage. It is particularly important to pay attention to the design and wording of contractual clauses, as these are often at the heart of potential risks.
Contractual risks often lurk in the details, particularly in certain clauses that can easily be overlooked when reviewing a contract. These clauses can harbor significant risks and should therefore be treated with particular care. Some of the most critical contractual clauses and the associated risks are considered below.
Force majeure clauses release a contracting party from its obligations if unforeseeable events such as natural disasters or political unrest occur. These clauses are necessary in order to regulate any loss of performance through no fault of one's own. However, they entail risks if they are formulated too vaguely or are one-sided in favor of one party.
An example of an unfair force majeure clause would be a construction company using vague wording to declare any delay, for example due to slightly bad weather, as force majeure. Although construction work could continue after a few days, the company uses the clause to justify a long delay while completing other projects. The real estate developer suffers financial losses as a result, but cannot claim compensation due to the unilateral clause.
It is crucial to agree clear definitions and regulations on the consequences of a force majeure event in order to avoid misunderstandings and legal disputes.
Limitation of liability clauses specify the amount up to which a party can be held liable in the event of a breach of contract. While these clauses are intended to minimize the financial risks for service providers, they can pose considerable dangers for the contractual partner, especially if they concern security or data protection breaches.
In August 2012, a serious software error at Knight Capital, a major financial services provider, led to a significant trading error on Wall Street. The company was using new trading software that incorrectly executed millions of stock orders due to an accidentally activated old code. Within just 45 minutes, a loss of 440 million US dollars was incurred, bringing the company to the brink of collapse and leading to an emergency sale a few days later to avert insolvency.
An effective limitation of liability clause could possibly have significantly limited the financial damage. The purpose of such clauses is to limit the maximum loss that a company must bear in the event of errors to a certain amount. Had Knight Capital included such a clause in its contracts, the loss would probably have been limited to a controllable level, which could possibly have prevented the forced sale of the company.
*It is important to bear in mind that ultimately one party must pay for the damage caused and that this case took place in the USA, where different legal regulations apply than in Germany.
It is therefore important to check such clauses carefully and ensure that they do not pose any unreasonable risks to your own company.
Indemnification clauses oblige one party to the contract to indemnify the other party against certain damages, losses or liability claims. These clauses are often formulated in a one-sided manner and can lead to an imbalance in the distribution of risk, as in the following example.
A software developer concludes a contract with a large company to develop a customized software solution. The contract contains an indemnification clause that obliges the developer to indemnify the company against all legal claims arising from the use of the software, regardless of the cause. After the software has been properly delivered, incorrect use by the company leads to a security vulnerability. A customer suffers damage as a result and sues the company.
Despite the fact that the error was caused by the company's improper use, the developer must bear the legal costs and claims for damages due to the indemnification clause. This situation illustrates how unfair such a clause can be, as the developer is held liable for something that was beyond their control.
It is essential to ensure that indemnification clauses are fair and balanced in order to avoid unexpected financial burdens.
Dispute resolution clauses define how contractual disputes are to be resolved. Tiered dispute resolution clauses are particularly useful as they provide for a gradual escalation in several stages from negotiation to mediation to arbitration. This structure can help to resolve conflicts efficiently and without expensive court proceedings. However, such clauses must be clearly formulated in order to avoid misunderstandings.
In a contract between a supplier and a manufacturer, a staged dispute resolution clause is agreed. First, a negotiation between the managing directors should take place, followed by mediation, and if no agreement is reached, arbitration should take place in a specific country (in which a neutral body decides outside the jurisdiction of the state).
If the clause remains unclear, for example with regard to deadlines or the selection of the arbitration tribunal, problems can arise. For example, the manufacturer could initiate arbitration proceedings immediately after a failed mediation, while the supplier insists on a further round of negotiations. This could lead to undesirable legal disputes that could have been avoided if the wording had been clear, specifying the exact deadlines and the competent arbitration tribunal.
A contract should also contain a clear and fair termination clause, especially in long-term contracts. Without an early termination clause, a company may be trapped in a costly and unfavorable contract. It should therefore be ensured that termination is possible due to legal changes or non-fulfillment of contractual obligations.
A company concludes a long-term supply contract without a clear termination clause. When the supplier delivers inferior products due to increased raw material prices, the company is bound by the contract and has no easy way to terminate it prematurely. A clear termination clause would have allowed the company to terminate the contract in good time if the obligations were not fulfilled or if circumstances changed.
These contractual clauses are just a few examples of potential contractual risks. They illustrate how important it is to check contracts carefully and, if necessary, seek legal advice to ensure that no inappropriate risks are taken. Careless handling of these clauses can have serious financial and legal consequences.
However, many companies use general terms and conditions in most contracts, as these standardized clauses usually speed up the conclusion of the contract many times over.
In the B2B sector, general terms and conditions (GTC) are an indispensable tool for efficiently regulating business relationships. As it would often be time-consuming and costly to negotiate all contractual clauses individually, GTCs are almost always used as a starting point. In contrast to the B2C sector, where the consumer is more comprehensively protected, less stringent regulations apply in the B2B sector. This means that T&Cs are often tacitly included without having to be explicitly referred to. But this is precisely where the contractual dangers lurk.
In B2B transactions, tacit consent to the GTCs can be assumed, especially if there is an ongoing business relationship between the parties or if commercial practice requires the use of GTCs. But be careful: even if the formal reference to GTCs is not always necessary, you should ensure that they are effectively included in the contract. Otherwise, you run the risk of critical clauses not applying and the statutory provisions taking effect instead.
Another risk is the use of ineffective GTC clauses. Although less strict rules apply in the B2B sector, there are exceptions. For example, clauses that limit liability for intentional or grossly negligent breaches of duty may not be used. Warranty exclusions are also only permitted to a limited extent. If such clauses are ineffective, there is not only the threat of legal disadvantages, but also expensive warnings.
Another common problem in the B2B sector is the so-called "battle of the forms", in which both parties try to enforce their own GTCs. In such cases, contradictory clauses can arise, leading to legal uncertainties. In addition, liability clauses should be examined particularly carefully, as inadmissible clauses can lead to the company being held liable for all damages.
T&Cs offer a practical way of structuring contracts efficiently, but they must be used correctly and in compliance with the law. A comprehensive legal review of the GTCs can help to avoid costly mistakes and put the contractual relationship on a secure footing.
Contracts are the backbone of every business relationship, but they harbor considerable risks if they are not carefully reviewed. From financial losses and legal disputes to reputational damage - the risks are manifold and often underestimated. This makes it all the more important not only to negotiate contracts carefully, but also to keep an eye on them at all times.
This is where ContractHero comes into play. With ContractHero, companies can efficiently analyze their contracts and quickly identify critical contract clauses. The tool makes it possible to filter for specific content and thus identify potential risks at an early stage. ContractHero thus enables the management of all contract information on a central platform, effectively optimizing your contract management. In addition, automatic reminders ensure that deadlines are met and important dates do not pass unnoticed. ContractHero therefore offers valuable support in minimizing contractual risks and putting your business relationships on a secure footing.
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Disclaimer:
The contents of this article are for information purposes only. It is not legal advice and no liability is accepted for the contents.
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