Risk e-Views Vol 15 December 2011 – Risk Leadership: Facing Extreme Contractual Liability Risk

Facing Extreme Contractual Liability Risk

“Who is to blame?” How often do we read that line in a newsletter or magazine article about a legal dispute when it all went wrong? Too often, we ignore those little clauses in contracts called indemnities. A slight change in wording in an indemnity can vastly change the circumstances of who pays how much if it does all go horribly wrong. Sometimes the contract gets signed without proper legal review and when we do have legal review, we often suffer from either the Optimism Effect or the Pessimism Effect.

Optimism Effect

The optimism effect is the “It won’t happen to me!” attitude. Even worse, it may be the extreme “Don’t be absurd. Get on with your job!” attitude. The result is often exposure to events that can shatter an organisation leaving the optimists ashen faced saying “I can’t believe it!”.

Pessimism Effect

The pessimism effect is where commercial reality meets intransigence. Some principals simply will not budge on their insistence to transfer unreasonable levels of risk onto the contractor. Pessimistically, managers may say to themselves “Someone is going to take on this risk which they could never manage or afford to fund if the event occurs. We can’t cut ourselves out of the market completely. We have to agree to the indemnity”.

As a Risk Leader in your organisation you need to be aware of the optimism and pessimism effects. You need to help decision makers consider the certainty of the upside the sales people are predicting vs the remote but potentially company-destroying risk of a one-sided indemnity clause. As a Risk Leader your most valuable tools in these instances are a well articulated risk appetite for the organisation, signed off by the CEO/Board, along with some statistics about issues in similar contracts.