The contract dilemma

All firms involved in trading freight and commodities have access to extensive networks of knowledge. The way a company harnesses and applies this knowledge to its business activities is central to its success. Unfortunately, much too frequently there is no systemic way or process to ensure that this knowledge is gathered and applied consistently during some of a company’s most risky activities. The process of creating and issuing freight and commodity contracts is one of these activities: there is always the possibility that contract creation will put a company at unknown or unplanned risks. Often, the identification and management of risks during contract negotiations have relied on experienced and watchful people, consistently applying their knowledge and understanding to mitigate these risks. But is that good enough? If they have an off day it could cost the company millions.

And it’s not just having to rely on the knowledge of individuals that creates unnecessary risks. It’s a fact that risks can and do change both during and after contract issuance; assessing open contracts for emerging risks can be very problematic and expensive. Being able to identify contracts which have become more or, possibly, less risky allows a company to take the appropriate measures to manage risks.

So having manual systems begs the question, ‘would you risk millions on the off-chance that humans are perfect?’ Your answer would, of course, be a very emphatic ‘no!’ So why are so many companies willing to risk millions on legacy technology, manual processes and luck? And for some companies in the global shipping industry, this approach to contract creation and risk management, together with a reluctance to embrace new methods, has resulted in significant setbacks in achieving anything close to efficiency or risk awareness, let alone the ability to reduce risks to a minimum.

The devil’s in the detail

One area that is repeatedly a cause for concern is poorly drafted contracts and an industry reliance on out of date, incorrect or risky clauses. The idiom “the devil is in the detail” could not be more appropriate to our industry and this time, as it refers to a catch or an element of surprise hidden in the details. Our industry is built on a mass of contracts, clauses and sub-clauses and just “getting the detail right” is a full-time job for many people. This is where the unwillingness to embrace new approaches and the low appetite for innovative solutions is making the whole contract creation process much harder than it should be and which, in turn, allows unknown risks to become part of an agreement – and if you have an unknown risk, you can’t even begin to manage it.

With many market participants managing their contract creation processes using a combination of manual actions and desktop software such as Microsoft Word, email, faxes, shared drives, etc, what was once “the way forward”, perhaps twenty years ago, is now so limiting as to be a significant risk point.

Organisations in the shipping industry have not historically been good at sharing information across the business; this is rarely automated and extracting useful information from a sea of data, on an ad-hoc basis, becomes very expensive and time-consuming, assuming it’s even possible. This approach can result in errors, and incur high costs, as well as having to rely on experienced individuals utilising their knowledge to spot and resolve issues.

“Our industry is built on a mass of contracts, clauses and sub-clauses and just “getting the detail right” is a full-time job for many people”

With more and more litigation over contracts, costly settlements and changing regulation, using manual systems and processes is quickly becoming untenable. Relying on manual systems also makes it extremely difficult to identify and manage risk. For example, should a trader really be expected to go through a 50-page contract and try to extract useful information out of it, in a timely manner? This is inefficient, slow, prone to error and undoubtedly very frustrating. On the other hand, having a secure platform which allows the trader to see a high-level summary of the key points of the contact, not only makes for a much more secure process, but it also allows for real-time contract and risk management.

How do you ensure that your teams of traders, brokers and the back-office have the latest information to hand and know how and when to use it? Best practice is not just an abstract term for the industry but, most importantly, for your own organization it means ensuring that your teams across the world, or even just across the room, understand how and when to apply clauses according to your organisation’s own standards base, for instance, on BIMCO clauses.

Change is normal, progress is hard, and managing it is harder still. Technology provides the potential to meet these challenges. There is a lot of technology out there and we already rely on it in our personal life – be it watching videos on the phone on the commute home, ordering the groceries to be delivered or researching the best price for next year’s holiday – so why are we slow to get the most out of technology for our businesses? It is strange that we turn to sub-optimal technology within manual processes to ensure we correctly draft contracts worth many millions of dollars.

Corporate learning is the answer

So what’s the answer? Companies like BIMCO put a lot of time and effort into creating standard clauses, which are clear, up-to-date and safe to use. The problem comes in communicating these changes and ensuring that the right, up-to-date clauses are used at the right time. Capturing knowledge about the use of clauses from within the business and from external providers is crucial to understanding when and how to use a certain clause. Sharing that knowledge during the whole contract creation process from beginning to end, means that all users can make informed decisions on any element of the contract, clearly understanding, and thereby significantly reducing, the associated risks.

“Incorporating corporate learning into systems means that all the lessons learnt by everyone in the organisation are there for everyone’s use, and it means that an organisation is able to reduce its dependence on the experience and knowledge of an individual employee.”

Incorporating corporate learning into systems means that all the lessons learnt by everyone in the organisation are there for everyone’s use, and it means that an organisation is able to reduce its dependence on the experience and knowledge of an individual employee. When this is applied to contract creation, everyone involved in the process has real-time access to relevant, centralised information and can make an active and informed decision about any possible risks.

The best solutions will ensure that all the stakeholders in the company have access to the same information, the same clauses, and a full audit-trail. It also means that corporate learning is embedded into the process of creating contracts. Technology really can deliver on its potential and promise when it helps to inform decision-making in a consistent and repeatable manner, and it creates an environment which supports true collaboration, connectivity and visibility. This removes uncertainty between counterparties and makes the negotiation process easier, quicker and more efficient. This also strengthens valuable working relationships and enables lessons learned to improve future performance in contract negotiations and risk management.

The post originally appeared as a guest post in BIMCO Bulletin (2016, Vol 111 #1 at 54-55).