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5 Tips for Recession-Proofing Your Business Contracts

Contract risk is a tough nut to crack for most. Staying ahead of lurking contract risks can prove to be challenging for the best of organizations even when times are normal.

And now with the waves of economic uncertainty that we are facing today – contracts are likely to become even more vulnerable to risk, value leakage, and in the worst cases, even termination.

Contracts being the backbone of all economic activity will suffer some of the most serious shockwaves.  And because of this, legal teams are in a unique position to be able to help their businesses stay afloat in these uncertain times.

With the right planning and due diligence, your contracts can be recession-proof and inflation-proof, helping you maintain a sustainable business even in challenging times.

We have put together a list of 5 actionable ways in which you can recession-proof your contracts and get the best value out of your agreements as you step into the new year:

1: Safeguard your contracts against supply chain turbulences

Economic downturns have a huge impact on the supply chain, slowing flows of cash, raw materials and final products. As per a study by Accenture, 94% of Fortune 1000 companies faced supply chain disruptions as a result of Covid-19. (Accenture)

To safeguard your contracts against supply chain turbulence caused by economic downturns, it is essential to carefully analyze your suppliers and their on-going capacity to fulfill their contractual obligations.

This includes assessing their cashflows, raw material availability, prices, and regulatory data, as well as reviewing any existing insurance certifications.

Legal and compliance teams must be quick in analyzing how exposed their contracts are to risk. All supplier data should be readily available to scan through quickly.

Here are safety nets that you can put in place:

  • Vendor Consolidation & Finding Back-ups: Companies choose to let go of multiple suppliers, and aggregate within fewer partners to enjoy volume discounts; whereas some protect against raw material availability by arranging for alternatives.
  • Altering payment terms: For your long-term vendor contracts, you can try to get on monthly payment terms instead of getting into long-term payment commitments where possible in order to save cash.

2: Safeguard your contracts against price fluctuations

In times of recession, contract pricing can change frequently and unexpectedly, putting a significant strain on businesses. And due to manual or slow processes, legal teams can often miss out on evaluating contractual levers associated with duration/term, indexing, and price increments. This can put a dent on the company’s bottom line.

One important legal provision that can help companies manage these fluctuations is the price adjustment clauses.

A price adjustment clause is a legal provision that requires prices or other monetary amounts to be adjusted periodically based on the relative change in value of one or more established and agreed upon price indices. This is especially useful if you are engaging in longer-term contracts, and it can protect the interests of all parties involved.

This clause allows for periodic adjustments in prices or other monetary amounts based on real-time changes in market conditions. It provides an important tool for managing contract terms during periods of economic volatility. Whether you are negotiating new contracts or reviewing existing agreements, being aware of the price adjustment clause can help you get the best deal for your business.

3: Brace against change in demand: protect sales, employment and procurement contracts

As the economy enters a period of recession, demand for goods and services can fluctuate significantly. To protect your business against these fluctuations, it is important to consider contract terms that will help you adapt to changing market conditions.

Sales contracts are particularly vulnerable to this fluctuating demand. This can lead customers to cancel existing orders, delay accepting deliveries, or seek discounts and lower-quality products. To protect against these risks, it is important to perform a thorough risk assessment and make a mitigation plan that protects against potential changes in market conditions.

Here are some steps you can take:

  1. Identifying at-risk customers: Identify which customers are more vulnerable to recession and may go back on commitments. For customers that are forecasted to pull out of agreements, try incentivizing them with preemptive renewals for cash discounts.
  2. Flexible payments and discounts:Contract terms that allow for greater flexibility in order quantities or payment schedules, as well as legal protections such as contract termination clauses in the event of poor performance by the customer. Additionally, it may be beneficial to offer your customers incentives such as early payment discounts or volume rebates in order to maintain relationships and ensure steady revenue streams during this vulnerable time.

Another key area that is likely to be affected by demand fluctuation is labor. Employers will likely face variable demand for their products and services but they need to find a way to maintain high levels of productivity and output amidst budget cuts.

In order to protect the rights of employers and employees while still managing ongoing projects, it is crucial to carefully consider contract terms and legal considerations during times of recession. With careful planning and attention to detail, businesses can successfully navigate these troubled waters.

Here are some steps you can take:

Turn to flexible staffing: Flexible staffing strategies can include onboarding contract workers, utilizing workforce-as-a-service providers, or taking other measures to adapt quickly to changing conditions in the workplace. Because these arrangements are subject to various legal requirements depending on your region and industry, it is important for employers to carefully review their employment contracts and ensure that they have all the necessary regulatory checks in place.

Overall, flexibility in employment is critical for businesses looking to weather the economic storm and remain competitive in our current climate. Whether you are hiring contract workers, partnering with a workforce-as-a-service provider, or making other changes to adapt to the current market conditions, it is essential that you take proactive steps to ensure compliance and protect your business.

Lastly, buy-side contracts also need to be protected against fluctuations in demand.

It is important to keep your vendors on the same page and discuss changes in your requirements because of altered demand. Expectation setting and renegotiating can protect your firm from inventory bulge, liquidity concerns etc.

Here are some steps you can take:

  • Manage expectations and commitments with suppliers: If your business volumes are forecast to be low for the short-to-medium term, you should review volume commitments to suppliers under longer-term agreements and proactively discuss and change them.
  • Explore new modes of payment to suppliers: In uncertain times when accurate forecasts are not possible, you can also explore the possibility of profit sharing. Initiate discussions with important vendors and partners to share risks and rewards.

4: Protect the liquidity of the company:

Liquidity can suffer in times of market volatility. If a company’s customers stop buying from them but their suppliers keep shipping parts or raw materials, they can experience an “inventory bulge,” or a “working capital bulge.” This traps all the company’s cash in an undesirable form – inventory.  And unable to quit their contracts, companies can be forced to keep buying inventory.

To protect against an inventory bulge and help maximize cash flow, companies may need to explore alternative contract models with their suppliers, such as profit-sharing agreements or other arrangements that incentivize both parties to reduce inventory levels. Additionally, companies should be proactive in identifying potential contract renegotiations early on and taking steps to mitigate any risks associated with these changes.

Another similar phenomenon that businesses can face is the “profit squeeze.” This occurs when customers stop buying or delaying payment for products or services that a company has already ordered, but the company is still required to pay its suppliers on time.

In order to manage a profit squeeze successfully, it is important for businesses to carefully assess their contract terms and cash flow needs, as well as ensure they are adhering to all relevant regulations. Additionally, businesses should take proactive steps to reduce their reliance on a single customer or supplier and diversify their sources of income wherever possible.

Include explicit termination clauses with detailed provisions that allow cancellation only under specific circumstances, not at will, simply for convenience. Specify terms of terminations and minimum notice before termination as well as prorated fees before exit.

5: Re-evaluate Current Contractual Relationships & Obligations

While contract pricing and other terms are important, they are not always sufficient to ensure contract success. In order to effectively manage contract risks, it is also important to develop strong relationships with your suppliers and partners. By fostering trust and collaboration, you can work together to navigate contract challenges and achieve greater business success.

Contracts that are already signed and on the back burner, such as evergreen contracts, and auto-renewed contracts need to be brought back to the drawing board to re-evaluate the relationships, terms listed in them and their validity in current times.

For each of the critical categories, legal teams should identify contracts that are being renewed in the next 90 days to judge if there is any wiggle room to renegotiate more favorable terms. Successful contract re-negotiation requires quick access to contract terms, renewal dates, spend data, and good relationships with the key budget owners.

For business-critical systems, you can try to renegotiate the price if there are features inside a product that your stakeholders aren’t using. For products that aren’t that critical, reconsider if you even need them, before renewal cycles, ask the stakeholders and users of the product about its usage and the workflows dependent upon it. The main priority currently is to remain profitable and to continue to enable your revenue engine, anything that does not contribute to these items is dispensable.

Here are a few ways in which Zycus’ AI-based contract management tool can help:

Access to data is the most critical element in all the 5 tips mentioned here, because survival and profitability are all about the speed at which decisions can be taken. Easy access to clause level information including the specific language you’ve agreed to, key supplier metrics, etc. can help make business critical decisions in time.

Zycus’ CLM solution ensures you get easy and timely access to this data, housing all your executed contracts centralized in one single, digital repository.

Additionally, it can also help you configure alerts & reminders and notify stakeholders of upcoming milestones/renewals so that contracts don’t slip through the cracks and can be timely re-evaluated or re-negotiated before renewals.

Zycus’ Merlin Insta Review helps identify risk associated with suppliers along with suggestions to mitigate these risks. This can help you take proactive measures for suppliers facing bankruptcy (financial) risk, operational risk, catastrophic risk, reputational risk etc.

It is also possible to identify information at the clause and contract level. For example, for contracts that are covered under the Force Majeure clause, you can identify clauses, check the extension period in the case of Force Majeure, and if confirm if termination is applicable under Force Majeure.

With the right tools, careful planning and strategic management, businesses can protect themselves and continue to drive growth and success in today’s challenging economic climate.

Conclusion:

Contract risk will grow manifold as we go deeper into this recession. Taking pre-emptive action on your contracts and putting in safety nets will be important to ensure profitability and optimal returns from any signed agreement.

If you would like to read more about how legal teams can recession-proof their contracts and help their businesses stay afloat in these uncertain times, download our latest eBook – In-House Legal Team’s Playbook for Recession.

Author

Anthony Scannell is the Director of Sales at Zycus, a leading provider of cognitive contract software solutions. With over a decade of experience in the field, he has become a subject matter expert for Contract Lifecycle Management (CLM), helping organizations streamline their contract processes, increase compliance, and reduce risk. Anthony’s expertise in CLM has helped numerous clients achieve their contracting goals and drive bottom-line results. He is known for his deep understanding of the complexities of the agreement process and his ability to present solutions that meet the unique needs of each client. Anthony’s dedication to customer success and his passion for CLM make him an invaluable asset to the Zycus team.
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