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Key Contract Terms to Prevent Financial Risk

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Preventing financial risks within contracts is vital for business stability and protection. For instance, risk management to prevent financial risk can help manage several potential problems and encourage stable business cash flow by avoiding threats such as customer payment delays, which could otherwise be highly damaging to a business. This article will explore critical clauses your business can include in its contracts to prevent financial risk. 

Which Types of Contractual Financial Risks Could You Face as a Business?

As a business, you could face a range of financial risks which could significantly impact your business cash flow and profitability. 

 Various risks include:

  • the risks of customers failing to pay invoices on time, impacting cash flow;
  • the risk of customers going insolvent, meaning loss of business or contract termination; and
  • market conditions, meaning there are increases in your costs as a business, with the potential to impact profit margins and your financial gain under specific contracts.

As such, it is vital to consider how to protect yourself as a business contractually from potential financial risks.

Which Contract Terms Could Help Prevent Financial Risk?

As a business supplying products or services to customers, robust contracts to mitigate financial risk should be a key priority.  

 Key clauses to help prevent financial risk include the following:

  • Robust Payment Terms: Determining a detailed payment schedule and setting payment terms can significantly reduce financial risk. For instance, by stipulating that customers must pay within specific timeframes, such as 30 days. Further, penalties for late payment can encourage prompt settlement of invoices. You can, for example, include clauses requiring customers to pay interest if they settle their invoices late; 
  • A Dispute Resolution Process: Financial disputes can be highly stressful, time-consuming, and costly. As such, having a process to address such conflicts can curtail these risks significantly, saving both time and costs. For instance, your contract can build in methods encouraging alternative dispute resolution to settle financial disputes, such as a mediation or arbitration procedure to resolve customer payment disputes;
  • Termination and Remedies Protection: Working with customers can be challenging, particularly if they put your business at financial risk of delivering work without payment. For instance, you may be working with start-ups that cannot afford to pay your invoices or with companies that may struggle financially due to market conditions. Contract remedies can be invaluable to protect your business from such risk. For instance, including contractual terms allowing you to suspend your services or terminate your contract if a customer fails to pay; 
  • Guarantee Protection: In circumstances where a customer’s financial stability is uncertain, your contract could include a guarantee clause requiring a third party, such as a parent company, to guarantee the performance of the customer’s contractual obligations. This can offer an additional layer of security should you be uncertain about the customer’s financial position and credit risk for your business. For instance, when working with brand-new companies; and
  • Payment Indemnification: Where there is significant financial risk, this clause serves as a safeguard by stipulating that the customer will indemnify (compensate) your business in case of losses, damages, or liabilities incurred due to payment-related issues. For instance, this clause could allow you to recover costs from the customer for chasing unpaid fees. However, customers will often negotiate this type of provision heavily, and you may need to seek legal advice if so. 
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By incorporating these types of clauses into your contract, your business can effectively mitigate financial risks. In addition, it can trade with greater peace of mind.  

However, it is crucial to note that every business operates within its unique risk background. Therefore, each contract should be accurate and tailored to address the specific financial risks the relevant business may encounter.

Seeking legal advice during the contract drafting process is essential. This can ensure that the clauses to protect financial risk are legally sound and effectively tailored to your business’s needs. 

Your business should also ensure its terms are reasonable and balanced, particularly when trading using your standard terms. The wrong types of clauses have the potential to confuse or put off customers. Experienced contract lawyers can help you navigate the best way to protect your business both contractually and by ensuring your terms are reasonable enough to keep customers happy. 

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Expert commercial lawyers can also help identify potential financial pitfalls and provide guidance on best practices for contract risk management. By investing in early legal advice, businesses can enhance the effectiveness of their contracts. This can help protect against various financial risks. 

Key Takeaways

Various financial risks could arise during a contract’s lifecycle, resulting in financial losses for your business. By integrating critical clauses into its contracts, your business can enhance its contractual protections against various financial risks. 

These may include remedies for late payment, termination rights, and transparent dispute resolution procedures to address financial disputes effectively. 

As each business has its unique risk profile and potential risks, seeking legal advice on your contract terms is vital. Legal advice will help ensure that the financial risk prevention clauses are legally sound. A lawyer can also ensure they are enforceable and tailored to your business operations. By investing in legal support, your business can strengthen its contractual safeguards and navigate potential financial uncertainties with greater assurance.

If you need help with a contract to manage financial risks, our experienced commercial lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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Sej Lamba

Sej Lamba

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