A short case study.

A manufacturing client inadvertently agreed to supply a space rocket part on the customer’s terms.  By agreeing to this, the manufacturer was unknowingly agreeing to accept unlimited financial responsibility for any discrepancies or defects in the part, which meant accepting responsibility for almost every failure by the manufacturer, no matter how minor or how remote that failure was from causing any loss or damage to the customer (eg; if late delivery of the part by one day held up the entire space programme).

The losses to the manufacturer could have been astronomical (pun intended), especially since the value of the order was only £100.

From a legal point of view, the extreme disproportionateness of the risk against the value of the order could work in favour of the manufacturer, and there would be other legal defences that could be constructed.  However, with the potential for wasted management time and the costs involved in getting tied up in legal wrangles, was it really worth it?

It’s all about risk management

The key point is that our manufacturer did not know on what terms it was supplying the part or what the implications were for the business. In other words, it wasn’t making an informed decision.  Making an informed decision is about understanding the legal risks you are taking so that you effectively manage or minimise those risks. In Lawpoint’s view there are three questions that need to be asked:

  1. What legal risks am I facing?
  1. What is the likelihood of the risks becoming a reality?
  1. Can I live with the worst case scenario?

Making it worth it

In this case, these questions had not been fully addressed. If they had, the order would probably not have been fulfilled without first trying to reduce some of the risks to ensure that they didn’t outweigh the benefits of fulfilment.

Possible measures to redress the balance could have been to negotiate new commercial terms (e.g. a new price or volume commitments from the customer);  and/or negotiate legal terms (e.g. the manufacturer’s liability); and/or invoke specific quality controls for a “risky” order.

Solutions

The manufacturer should have known that it had received a slightly unusual order in the first place.  If not, what could have been done to at least bring this order to management’s attention or minimise the risk of it slipping through the net?

Two key things could have been considered:

  • a simple process to highlight that orders that were out of the ordinary might need further consideration; and/or
  • a system to acknowledge orders that would minimise the chances of the customer’s terms applying if the order details did slip through the net.

The bigger picture

It’s easy to get carried away with the day to day stuff without taking a step back to look at the bigger picture and asking yourself about the potential legal risks that your business may be facing.  Apart from the direct impact on losses, if you ever wish to sell your business or get finance, potential buyers or investors will assess the legal risk that the business is exposed to and will often use this as a reason to negotiate down on the purchase price or to get more stringent finance terms.

This short case study highlights legal risks in relation to trading contracts, which will of course affect every business. But there are other legal aspects to your business that you should consider and, depending on your type of business, these may include the legal risks associated with, for example, employment, property, data protection, intellectual property, etc.)

Let’s get real!

Ok, so not everyone receives orders for space rockets, but businesses do face real contractual issues every day. One web designer client used a template contract for its customers, but this inadvertently gave away the designer’s intellectual property.  Another client had a good set of terms of business, but the terms never actually applied to some key customer accounts because of the contracting processes that were in place.

Asking yourself the right questions is key, but there is no need to lose perspective. It’s about working out what you can live with, then managing, minimising or eradicating what you can’t.

For a larger business, or a business that is growing quickly, it’s easy to visualise the benefit of a legal risk management strategy but, for a smaller business, even a one person consultancy, the issue of legal risk still needs to be addressed. Your strategy should, of course, be proportionate to your business needs, which means that you won’t need to go overboard and turn this into an unnecessarily complicated and lengthy process.

And in case you’re wondering…

A happy ending! The manufacture and delivery of the rocket part went as planned with no claims that I have heard of.