Risk Management In Commercial Relationships

Ricardo Redondo, Associate in ARIAS Costa Rica, expert in Commercial Law, shares this article on how the effective management of contractual risks is key to the success of any transaction. 

Contractual risks can be defined as those future and eventual circumstances that, within the framework of a legal relationship of a commercial nature, have the potential to generate adverse or destabilizing effects on one or both parties to the contractual relationship, or even on third parties outside the contract. For its correct identification, from the initial stage of analysis it is pertinent to classify it based on both its origin and its legal consequences. From a causal perspective, these risks may arise from the direct conduct of the counterparty, from the intervention of a third party unrelated to the obligational relationship, from extraordinary events such as fortuitous events or force majeure, or even from the negligent and/or inappropriate action of the affected party itself. From the point of view of their effects, these can translate into significant disadvantages, such as economic losses, reputational damage or legal consequences, as well as undue benefits derived from contractual terms or conditions that are considered abusive or asymmetrical. 
 
Based on the legal and economic effects produced, risks can be classified into the following categories:  

These risks can occur at different times in the life cycle of a contract, depending on the stage it is in. Different actions can be implemented or executed for its due mitigation. These would be the stages and the different actions that must be taken:  

It covers the entire initial structuring of the business relationship, from the initial study of the need for a contract to the preliminary phase of concrete negotiation of future terms and conditions. In this phase, there may be risks linked to an inadequate assessment of the real convenience or need to enter into a contract, a lack of knowledge about key aspects of the counterparty – both in terms of its legal capacity, solvency, reputation and experience – as well as the inappropriate choice of the type of contract to use. To mitigate the risks inherent in this stage, it is essential to establish formal corporate decision-making processes that include due diligence procedures aimed at gathering relevant information about the counterparty and the market (such as precedents, fair market value) organizational structure and compliance culture), as well as correct legal support for the selection of the contractual model most appropriate to the nature, complexity and specific risks of the planned operation. 

Once the contractual model has been defined and an exhaustive due diligence assessment of both the counterparty and the market in general has been carried out, the crucial phase of negotiating the terms and conditions that will make up the contractual document begins. At this stage, the regulatory content of the contract begins to be configured, a point at which the principle of contractual balance, considered the cornerstone of any contractual relationship, becomes vitally relevant. This principle establishes that the contract must be fair and equitable for both parties, guaranteeing an adequate balance in rights and obligations that avoids situations of abuse or significant disadvantage for any of the parties involved. Therefore, it is necessary to pay attention and avoid the inclusion of abusive or disproportionate clauses that can lead not only to the nullity or ineffectiveness of specific provisions within the contract, but also to the eventual total annulment of the agreement, affecting legal certainty and the trust necessary for the development of the commercial relationship. 

Therefore, it is essential that stipulations that define minimum standards of compliance and reflect the best corporate and commercial practices recognized nationally and internationally are incorporated at this stage. These clauses must cover, among other aspects, reasonable limitations of liability, penalty clauses that encourage timely compliance with obligations, clear provisions on early departure or termination, regulations relating to fortuitous events and force majeure that protect the parties against unforeseen events, confidentiality clauses to safeguard sensitive information, rules of jurisdiction that delimit scope and exclusivity,  as well as firm commitments in terms of integrity and anti-corruption that respond to current regulatory requirements. These stipulations must be carefully adjusted to the particularities of the business, the industry, and the context in which the contractual relationship takes place. 

Additionally, another aspect of utmost importance in the negotiation phase is the correct drafting and structuring of the provisions, terms and conditions of the contract. The clarity, coherence and internal uniformity of these clauses are essential to avoid ambiguous or erroneous interpretations that may give rise to controversies or conflicts during the execution of the agreement. To mitigate these risks, it is highly recommended to provide mechanisms that facilitate the joint and coordinated interpretation of contractual clauses, such as the formation of monitoring committees made up of representatives of both parties or the establishment of conciliation processes prior to the formalization of a legal dispute. These mechanisms allow a direct channel for dialogue and early resolution, promoting the preservation of the commercial relationship and the efficient fulfillment of the contract. Likewise, effective mechanisms for the resolution of conflicts must be established from this stage in the event that this clarity is not achieved in advance, including, but not limited to, extrajudicial processes such as mediation and arbitration, as well as the definition of the competent jurisdiction for judicial resolution, based on criteria such as subject matter,  the territory and the specialty. 

Depending on the complexity of the business, the industrial sector and the nature of the contract, it is common during this stage to resort to the use of pre-contracts or preliminary agreements, understood as provisional and temporary legal instruments that aim to lay the essential foundations for the preparation and formalization of the definitive contract. These pre-agreements make it possible to precisely delimit the negotiable points, the conditions precedent or resolutory and the prior commitments that must be fulfilled in order to move towards the signing of the main contract. In addition, to strengthen the negotiation phase and avoid risks associated with the disclosure of sensitive or confidential information, it is common to use auxiliary instruments such as confidentiality agreements, affidavits, and arbitration agreements, which contribute to an orderly, safe and predictable negotiation, establishing from the beginning the parameters and limits that will govern the relationship between the parties. The same rules in relation to the principle of contractual balance and the correct drafting of the clauses or provisions of the contract apply to the generation of these contractual documents.  

The moment of execution of the contract is the most important in the detection and mitigation of risks since it is at this moment in which the risks can occur or materialize and the effects of the legal liability of the parties begin, that is, it represents the moment in which the agreed obligations become enforceable, generating specific rights and duties for the parties. For this reason, it is necessary to maintain active vigilance against contractual breaches, third-party faults, regulatory modifications, or operational alterations of the parties. In such situations, it is appropriate to implement effective monitoring mechanisms not only on compliance with the terms and conditions of the contract, but also on monitoring mechanisms for the commercial and operational activity of the counterparty, as well as the use of corrective means and/or processes, such as addenda or contractual amendments, in order to keep the contractual provisions updated in accordance with the commercial reality of the relationship between the parties and the parties. to restore the balance of the obligational relationship. 

Once the contract has been terminated or expired, risks may materialize, especially if the business relationship between the parties has not yet been fully concluded. Therefore, it is necessary to implement measures that protect the residual interests of both parties and third parties. These include post-contractual confidentiality clauses, clear rules for the handling and processing of personal data collected within the framework of the contract, the restitution or destruction of strategic information, as well as the determination of the destination of goods shared or in the possession of the counterparty. All these measures must have sufficient regulatory and operational support to prevent subsequent contingencies. 

Throughout this contractual cycle, risk management can be enhanced through cross-cutting mechanisms that have been indicated. These include: 

The implementation of robust corporate policies can become a fundamental element in risk management, since they allow different aspects of compliance, quality standards, and business ethics to be addressed prior to any contractual negotiation. Having these types of internal rules as the basis of a negotiation contributes to the establishment of clear, uniform commercial relations aligned with good commercial practices, internal rules, and applicable regulations.   

In this sense, the adoption of international standards such as ISO 31000, issued by the International Organization for Standardization (ISO), is especially relevant. This standard provides a structured framework for risk identification, analysis, and mitigation, allowing organizations to establish systematic and functional policies for proactive contingency management. Likewise, guidelines such as the OECD Principles of Corporate Governance or its guidelines on business integrity and anti-corruption strengthen internal control and transparency schemes. 

At the same time, sectoral references can be adopted that offer specific guidelines according to the line of business, such as FEDEFARMA in the pharmaceutical sector, the Institute of International Finance (IIF) in the financial sector, or the International Chamber of Commerce (ICC) in the field of logistics and international trade. These associations or federations not only promote technical standards, but also responsible contractual models compatible with efficient risk management. 

Risk identification and management is not a one-off task, but an ongoing process that must be maintained throughout the contract lifecycle, in order to ensure that contractual conditions remain aligned with operational, social, commercial and regulatory changes. For example, for companies with a growing volume of contracting from suppliers or third parties, it is essential to implement automated systems that facilitate the identification and mitigation of risks periodically, thus contributing to the proper administrative and operational functioning of the organization. 

The best practice for building this culture of continuous risk management is to conduct consistent, regular audits. These audits must be carried out, in the first place, on the counterparty. In the case, for example, of a service provider, key performance indicators (KPIs) can be included to evaluate the quality of the service provided. Likewise, in the case of distributors, audits can be aimed at verifying compliance with specific standards, such as proper product handling, compliance with distribution routes, or compliance with business ethics policies.