Parties negotiating a business transaction don’t have to accept the risks or duties imposed by law on the proposed arrangement. For example, just because a property owner is generally liable for damage caused by hazardous materials on his or her property (42 USC §9607) doesn’t mean that a potential buyer can’t negotiate that the seller be financially responsible for cleaning up materials that were on the property before the closing date. Here’s how to (re)allocate risk in your next transaction.
Step One: Get the lay of the land. Before drafting risk allocation provisions in any agreement, you need to know where things stand, by determining the following:
- What’s the general nature of the duty or obligation of concern: is it contractual, tort-based, or statutory?
- Where does the obligation or duty lie absent an agreement?
- What is the scope of the obligation or duty?
- What obligations have the parties assumed, e.g., have any representations or warranties been given?
- To what degree do the parties want to transfer or eliminate the obligation or duty?
- Should third parties be entitled to rely on the allocation?
Step Two: Choose a risk allocation device. After resolving the initial questions, you can select the appropriate means of allocating the identified risk from one or more of the following devices:
- direct assignment of the risk to one party under the contract,
- indemnification provisions,
- exculpatory provisions or releases, or
Representations and warranties can also shift risks between the parties.
Now here’s the biggest issue: Will a court respect your contractual allocations of duties and obligations? Well, that may depend on the party’s relative position in the transaction. If both parties are major industrial giants, the courts generally respect their ability to evaluate and allocate the risk of a particular transaction. But if one party is a corporate giant and the other is an average consumer, the courts may subject the risk allocation agreement to heightened scrutiny.
All of these risk allocation devices are discussed in detail in CEB’s Drafting Business Contracts: Principles, Techniques and Forms, chap 11.
Other CEBblog™ posts you may find useful:
- What You Need to Know About Contract Start and End Dates
- Ask This Before Preparing Any Business Agreement
- Draft Agreements with Contract Construction Principles in Mind
© The Regents of the University of California, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.