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How to Stress Test Your Contracts Before Signing

     

Contracting is fairly standard practice for most companies these days, although some industries are more contract heavy than others. Even though individuals and companies have been entering into contracts for centuries now, these agreements still manage to cause problems, with contract disputes clogging up countless court dockets. Although some disputes may be unavoidable given that many things are beyond one party’s control, companies should take the appropriate precautions to determine whether they can withstand certain issues. Understanding where a contract could go wrong before actually signing it is a bit tricky given that contract performance will not commence until all terms and conditions are agreed upon and the final version is executed. However, here are some of the questions that the contract negotiation and drafting teams should be asking throughout their respective processes to stress test the agreement before either company signs on the dotted line:


What triggers liability?

The lawyers involved in drafting the actual contract will primarily be concerned with risk reduction and liability allocation, but other members of the contract team must also understand these matters. Depending on the type of contract, various actions or the lack thereof will result in the imposition of consequences, financial or otherwise, on the party who had agreed to assume liability for that particular matter. As a result, to ensure a well-balanced agreement is struck, the team putting together the contract must ensure that it is not one-sided such that one party will bear the brunt of any issues. If it does appear lopsided and compromise is not possible, it may not be a relationship worth continuing.


What will the financial consequences be?

Liability may result from a breach since this essentially means that one party has failed to fulfill its end of the deal, with the only remedy being the payment of damages. A default, on the other hand, may allow the defaulting party to take steps to rectify the situation. It is important for companies to scrutinize the contract for precise definitions of liability, default, and damages in order to be adequately prepared for any financial fallout. Of course, careful review may reveal that the company budget simply cannot withstand the potential consequences, and thus an alternative arrangement may be required.


Do we have the resources to handle any issues that arise?

Contracting relationships can run into all sorts of problems, many of which won’t even necessitate legal counsel or litigation. In some instances, the resources needed to resolve a problem will simply be the time of knowledgeable professionals. Granted, devoting hours and manpower to problem-solving may not be a big deal for some businesses, but for startups and small businesses, resources may be scarce and thus diverting them elsewhere may not be feasible. Companies need to ensure that they have the bandwidth to both perform as the contract stipulates and to make adjustments, as needed.


Can we recover, much less survive?

This obviously ties into the amount of resources at a company’s disposal, but it can also relate to reputation and goodwill. Although all contracts come with risk, some are obviously risky than others, and the ramifications of a breach may be too catastrophic to overcome. An important facet of stress testing any contract before committing to it requires a realistic assessment of various what if scenarios. Obviously, it is impossible to foresee all potential issues, but there has to be some attempt at examining where things could go wrong and how the company would, or would not, be able to address it.

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