LEGAL CHANGE

Operational risk – how to avoid falling into legal traps

---

About the author

Stephan Smoktunowicz is a banking & finance partner at the London office of the international law firm, gunnercooke. He helps businesses & people in the UK and across the world to achieve their commercial objectives and safely navigate issues that arise throughout any transaction lifecycle. He also provides training and mentoring to businesses, professionals and students on related topics.

---

In this issue

In 2023, the topics of incorrect signing of documents and mistaken security releases are just some of the business processes that have come under court scrutiny. Whilst operational oversights are not always fatal, businesses need to ensure that robust safeguards are in place to minimise the risk of them being so.

In this issue, I examine five key areas of the contract lifecycle that could become prone to operational errors and suggest ways in which businesses can minimise that risk.

---

POINTS TO NOTE

• From time to time, the English courts are asked to resolve disputes that directly or indirectly arise from operational processes going wrong.
• In a worst case scenario, defective operational processes could lead to agreements being unenforceable, or a party not being unable to rely on security or other collateral it thought it had.
• Businesses can take simple steps to mitigate and reduce operational risk, but this requires appropriate levels of awareness and clear, simple and comprehendible internal policies.

---

INTRODUCTION

Judgments from the English courts in 2023 have looked at things that can go wrong during the contract lifecycle. For example, the defective signature of documents and inadvertent release of security at public registries.

Whilst mistakes sometimes have no adverse consequences, the bottom line is if your business makes an operational error relating to an agreement, guarantee or security that you are relying on and you come out on the wrong side of a judgment, your business could end up significantly out of pocket as a result – and end up with a hefty legal bill too! So what can businesses do to avoid such expensive errors?

In this issue of Legal Change, I look at five areas of the contract lifecycle that merit particular focus and provide some tips on how to minimise operational risk.

---

THE CONTRACT LIFECYCLE – FIVE AREAS TO WATCH

Operational risk can arise at any stage of the contract lifecycle, but there are five areas that pose potential significant risks, namely:

• Drafting and the use of clause banks
• Signing and concluding agreements
• Registering documents
• Amendments, waivers and consents on existing agreements
• Termination and releases of existing agreements.

Let us look at each of these in turn.

---

DRAFTING AND THE USE OF CLAUSE BANKS

Getting draft agreements to customers quickly may feel desirable, because it can show that you are addressing their needs efficiently. However, in the quest for speed and efficiency, your business should still keep a close eye on how language is selected, translated and inserted into any agreement, if you want to ensure that it is fit for purpose and mirrors your commercial intentions.

Step 1: Selection of wording

Businesses who contract on their own standard terms often need to supplement or vary them at the outset to accommodate deal specific commercial requirements. This might be done by inserting additional or special conditions, with or without additional lawyer oversight.

However, whether your proposed wording actually works could require further careful thought. And even if your business uses or relies on clause banks of example wording to slot into agreements, it should never automatically be assumed that the wording is fit for purpose on any given transaction. In each instance, think about whether the wording needs to be ‘translated’.

Step 2: Translation of wording

Once the proposed wording has been chosen, your business should consider whether it needs any refinement before putting it into the agreement. For example:

• Is the wording legally robust and does it reflect your business’s true commercial intention, or could it be ambiguous and have different interpretations?
• Does any of the wording require any further expansion or explanation (e.g., more detail around a financial covenant)
• Does your business need the contract counterparty to provide anything to demonstrate compliance with an additional condition and has that been factored in?

Step 3: Insertion and final polishing of the wording

Once wording has been selected and translated, it then needs to be inserted into the agreement. That process raises further considerations, including:

• is an amendment needed to any standard terms to accommodate the extra language?
• does the new wording conflict with anything in the rest of the agreement and is that adequately addressed?
• what remedy is needed for a breach of any extra new condition and does the rest of the agreement actually cater for that?
• are there any cross border aspects to the parties or the agreement? If yes, have you considered taking appropriate local law advice on whether any further refinement is needed?(Always bear in mind here that Scotland and Northern Ireland have separate legal systems and requirements to England and Wales).

The use of AI and technology drafting tools

I have been an advocate and user of legal technology for many years and when used and maintained well, it can be a wonderful tool. However, it can only help with so much of the drafting process and it is not the best fit for all scenarios.

Therefore, irrespective of how good, fast, or accurate any technology is perceived to be, your business should never assume that AI/other technology has correctly captured the commercial intention for the specific agreement being drafted. That requires separate checks and balances and any quest for operational speed needs to be carefully balanced against the risk of oversights creeping in and key drafting points being missed.

Keeping an eye on things during the negotiation process

Drafting and negotiating any agreement is a living and breathing process. If your business is at any time negotiating an agreement without your legal team being present, never lose sight of the fact that changing wording previously approved with legal oversight, could have indirect consequences in the agreement that may not necessarily be apparent to the naked eye. What may look like a minor change could have a material and detrimental commercial impact if left unchecked.

Best operational practice – drafting and the use of clause banks

There are many ways a business could approach the drafting process, but the following operational considerations are worth bearing in mind:

Clause banks	If creating clause banks, consider including brief explanations of the effect of a clause and/or use appropriate health warnings for users. Also consider how clause banks will be periodically sense checked and maintained.
Drafting	If your business function is drafting wording, consider a policy on when and how that wording should be vetted (e.g., by in-house lawyers).
Intention	Discuss the commercial intent of any proposed wording with an in-house lawyer or external legal adviser to check it has the desired effect.
Policy	Consider a policy on who approves and signs off on the wording and the process required for that (including any changes to wording during customer negotiations).

By having some best operational drafting practice in place, it will help your business to mitigate the risk of your agreements saying something it never intended.

---

SIGNING AND CONCLUDING AGREEMENTS

Getting documents signed and dated is a second area of the contract lifecycle that can go wrong for any number of reasons, for example:

• Signatories signing in the wrong place
• The wrong signatories signing
• Witnesses not signing
• Execution/signing blocks being incorrectly worded
• Lack of framework or consensus on how to agree to date documents
• Documents being signed before board resolutions have been passed.

When things go wrong with signing, it can be a real headache for businesses, particularly when up against a customer deadline. In the heat of the moment, it may also lead to a blind eye being turned to a signing error for fear of holding up a transaction, missing a target date and/or damaging your reputation.

Where signing or the signing process is defective, it is best to not take unnecessary risks. Otherwise, you could end up facing future problems about the validity of your agreements, security or guarantees. So how can businesses build robustness into their signing processes?

Building robustness into signing processes

Consideration	Commentary
Which signatories?	Always consider which people will need to sign up front . This can vary depending on the type of entity (Company, LLP, Limited Partnership, Charity etc.) and specific constitutional rules may govern that. Additional requirements may apply on cross-border transactions. If in doubt, consult a qualified lawyer in the relevant jurisdiction.
Will signatories be available when they need to sign?	Mistakes may creep in if the signing process is rushed. Having a specific time slot for signing can help to marshall the signing process in an orderly way.
Witnessing	Always consider whether a witness is needed and whether an independent witness is available. Completions are sometimes delayed because a witness was not present to sign, or was not independent and that is easily avoidable through communication and planning.
Is a power of attorney being used, is it wide enough and still in force?	Sometimes, it may be necessary to sign an agreement under a power conferred by a power of attorney (for example, where it is an internal business requirement within a large organisation). However, a person’s authority under a power of attorney should not be assumed and it is important to check the terms of the power of attorney document to make sure it is effective. If you are unsure, check with a qualified lawyer.
Dating documents	Have an agreed mechanism with all relevant parties through which it is clear how documents will be checked, become effective and be dated. This is to avoid challenges that a party never intended an agreement to become effective, or that an agreement has become effective when you did not intent it to. Never assume that just because documents have been signed, that authority has been given to date and release them.
Electronic vs. wet ink signings	Electronic signings need to be carefully conducted, not least because public registries can have very specific requirements (e.g., HM Land Registry). If there are any foreign law elements to a transaction, local lawyers should be consulted to check that signing formalities work. A good understanding of the operational mechanics of signing platforms such as DocuSign and their limitations is also important to ensure the signing process runs smoothly.
Typographical errors	If a typographical error is spotted at any stage of the signing process, always consider taking legal advice before attempting to rectify it, to avoid any unintended consequences.

A well planned signing process where all parties understand what they need to do and how documents will come into force will avoid delays and minimise signing risks.

---

REGISTERING DOCUMENTS

You may have spent several weeks negotiating a new agreement and documents may have been signed. Time to celebrate – right? Whilst the signing of a transaction is an important milestone in the contract lifecycle, it is a time when businesses need to be very careful about taking take their foot off the gas, particularly if documents need to be registered or further steps are needed to protect your business interests.

Security registrations are a crucial part of the contract lifecycle as they may be necessary to protect both the priority of security against competing interests and to avoid insolvency related challenges. Failure to register your security on time could ultimately mean that you end up with nothing if the security provider becomes insolvent.

Other ‘post-completion’ requirements such as serving notices of assignment on contract counterparties, banks or insurers may also be necessary or desirable to protect against any competing interests. However, there are legal rules on how these need to be done and in any event, due diligence may be necessary on any contract rights which are being assigned to check whether they are any legal blocks to assignment and if so, whether you have robust contingencies.

Planning registrations & serving of notices

Planning post-completion registrations and notices should form part of any robust contract lifecycle planning process. Prompt registration and serving of notices have a number of benefits:

Issue	Benefits of acting promptly
Rejected/queried applications	Registration applications might be rejected on incorrect grounds or for unforeseen reasons. Applying for registration early at registries such as Companies House will provide you with better headroom to address any issues once the registration deadline clock is running.
System backlogs	Public registries do from time to time experience backlogs in registrations, IT issues and routine maintenance and therefore, it should never be assumed that an application made the day before a registration deadline will be accepted. Business policies which build sufficient time into registration processes to avoid such issues will be beneficial.
Return of original documents	Depending on how documents are signed, you may need to factor in time for the return of original documents so that in turn, they can be registered on time. If your business is attending to the registration process, it is best to have originals in your possession at completion to avoid the risk of post-completion delays. When dealing with electronically signed documents, thought is also needed as to who holds the original, as any copy of an original will typically need to be certified as such. Planning around how to deal with original documents will be far more beneficial than leaving things to the last minute.
Competing interests	In some circumstances, the date of registration at a registry or the date on which a notice of assignment is served could have a bearing on how well your business is protected if other parties with competing interests have registered or given notice of a similar interest. Proceeding without delay mitigates the risk of other parties having better protection, albeit if your due diligence reveals competing interests, their impact on your position should always be considered well ahead of signing.

Plan ahead by asking simple questions

Some simple questions for your business to ask whenever you conclude a contract are:

• Does it need registering anywhere? If so, where?
• Does notice of assignment need to be given to anyone? If so, to who and how does that notice need to be served?
• Is your business comfortable dealing with registrations or notices, or do you need to engage external lawyers?
• Are any non-lawyers in your business aware of the potential need for security registrations or notices and what might be required?
• Are there any cross border aspects to your transaction? If yes, consider whether local law advice might be needed.

---

AMENDMENTS, WAIVERS AND CONSENTS ON EXISTING AGREEMENTS

Changes to agreements arguably create some of the biggest risks for businesses during the contract lifecycle. It is therefore, key that your business builds in robust operational processes to manage risk. Some of the key considerations and risks are:

Consideration	Risks
Inadvertent and ineffective amendments	Amendments to agreements can potentially be made in various ways – e.g., by formal agreement, e-mail or verbally. That leads to two key risks: (1) amendments being made when not intended and (2) the method of amendment not working legally and/or not reflecting your business’s commercial intention. An agreement may also stipulate precise amendment requirements. Operational awareness of this is key to ensure that amendments only happen and only on the correct terms, when intended.
What are the knock on consequences of your amendments?	Think about this before amendments are made. For example, do you need consents or waivers under other agreements to make the amendment or could the amendment have an undesirable impact on your other agreements? Failure to consider these points could create unnecessary issues.
Waiver or consent?	There is a difference between a waiver and a consent and either could be conditional (i.e. with strings attached) or unconditional. Depending on whether you are the party giving or receiving the waiver/consent, careful consideration is needed around what commercial effect you intend the waiver or consent to have before entering into it. Otherwise you risk doing something which your business does not want to happen.
Inadvertent waivers and consents	As with amendments, an important operational consideration is how your business avoids giving waivers or consents it has no intention of giving (for example by e-mail or by conduct). Additionally, thought is needed on whether giving the waiver or consent in itself would breach or require a consent or waiver of any other agreements (for example, an intercreditor or master agreement). Whenever considering waivers or consents, always think what other agreements the agreement in question is or might be connected to, to avoid the risk of breaching or impairing your other agreements.

As with the initial drafting of an agreement, how amendments, waivers and consents are documented is important to ensure that they have the desired commercial effect. Operational processes should consider appropriate levels of legal oversight to ensure that the wording works.

Furthermore, where your business is relying on existing security or guarantees, an important consideration is whether any amendment, waiver or consent of an existing agreement affects that collateral. This can be a complex area of law and the impact should be considered carefully on a case by case basis to avoid guarantees or security from becoming ineffective and to ensure that you have the collateral cover you need moving forwards.

---

TERMINATION AND RELEASES OF EXISTING AGREEMENTS

As with amendments, waivers and consents, the termination of existing agreements and the release of contractual obligations, guarantees or security is a complex topic. Before terminating or releasing any existing agreement, guarantee or security, your business should consider pausing to ask some key questions.

Key commercial questions

• What do we expect the effect of termination to be on our existing contract, what is the actual legal effect of termination and do the two marry up?
• What is the impact of termination on our other contracts (e.g., does it automatically terminate another contract and is that actually desirable)?
• Are there any consequences of termination (e.g., early exit payment or break costs) and is our business comfortable with that?
• What process do we need to follow to terminate effectively (e.g., does the contract provide a mechanism or timeframe)?
• If we have any other contracts which refer to, or rely on definitions or provisions in a contract being terminated (e.g., for cross-default purposes) what are the consequences of termination on those provisions? Do they still work?
• Are there any timing or other considerations relating to termination or release (for example, do we need to be in receipt of repayment/payment sums before or contemporaneously with termination/release)? How will we ensure that works?

Given the potential complexities here, operational teams should consider factoring in adequate legal oversight to ensure there is no bitter post-termination aftertaste.

---

CONCLUSIONS

The contract lifecycle can pose a number of operational hurdles which need to be navigated safely in order to ensure that your business’s contracts and collateral have the intended commercial effect at all times.

There are many legal tripwires that can catch the unaware by surprise, but the risks they present can be mitigated through greater risk awareness across business functions and clear, simple policies which alert staff to best practice.