PETRI KESKITALO

From assumptions to risk management

An analysis of risk management for changing circumstances in commercial contracts, especially in the Nordic countries

The theory of contractual risk management and the default norms of risk allocation

SUMMARY

In Nordic contract law, the traditional way to deal with changing contractual circumstances has operated on the assumption that changing circumstances can be managed by categorizing the changes in circumstances either as foreseen or unforeseen. The dualistic perception of changing circumstances was useful as long as contract law was unable to find more precise tools for such an analysis. However, the increasing awareness of the unavoidability of risks in decision-making undermines the usefulness of such treatment for changing circumstances. Such a post-modern awareness of risks as an essential part of our world necessitates the creation of new tools of analysis because risks are now recognized as being more or less foreseeable. It can be assumed that the advocates of the test of foreseeability might find it attractive to argue that instead of abandoning the old tools, they could be adjusted by increasing the precision of the test of foreseeability through the adoption of the analysis of the probability of the changes. However, such an adjustment does not affect the awareness of the unavoidable risks in decision-making.

These changes in our understanding of decision-making under uncertainty suggest that an adjustment of the general doctrines on commercial contracts is in order. Consequently, Nordic contract law should abandon the test of foreseeability as the mental framework for treating changing circumstances. Even the ex post-oriented approach to the problem of changing circumstances, displayed by the concept of changed circumstances, should be abandoned in favour of an ex ante-oriented perspective, where the focus in directed away from the causes for changes in circumstances towards the management of the consequences of such changes. The change of the temporal perspective to contracts, in other words the adoption of an ex ante-approach, necessitates the terminological and conceptual separation of danger, risk, and liability. Together these methodological adjustments necessitate an adjustment of contract paradigms through an adjustment of the temporal perception of commercial contracts. Consequently, commercial contracts should not be seen as ‘recorded momentums’ that regulate the contractual obligations completely, once and for all. Neither should commercial contracts been seen as ‘processes’, where the content of contractual obligations is defined contextually by adjusting the contract to the changes in circumstances while preserving the contractual equilibrium as defined by the contract, as if the contract provided a sacred exchange rate. Commercial contracts should rather be understood as ‘managed processes’, where the contract parties have chosen a certain type of governance structure for their transactions that regulates the nature of the mechanisms of ex post adjustment of the contractual obligations. Together with the awareness of risks, this adjustment of the temporal dimension of the paradigm of commercial contracts will enhance our perception of commercial contracts as tools for management of commercial transactions.

The recognition of commercial contracts as tools for risk management necessitates the identification of the nature of such contractual risk management. Because of the novelty of the contractual risk management approach, it has been necessary to develop a theory of contractual risk management based on contract law, law and economics, and risk management literature. The proposal for a theory of contractual risk management consists of five phases:

1) Identification of business strategies,

2) Identification and evaluation of risks, including the risks created by the default norms of risk allocation,

3) Spotting and reconstruction of alternative contractual tools of risk management,

4) Evaluation and forecasting of the viability of the alternative tools of risk management, and

5) Contractual allocation of risks.

Whereas phases 1 and 5 are too contextual to be subject to analysis within the frames of this study, and a detailed analysis of phases 3 and 4 is excluded from the study due to the limitations of the time set for this study, phase 2 for the identification and evaluation of risks is limited to the analysis of the default norms for allocation of risk for changing circumstances. This analysis shows that the default norms need to be customized and adopted to the contextual needs of the contract parties and their contracting environment if the creation of credible commercial commitments and the protection of the contract specific investments is to be promoted. The analysis shows also that there has been an ongoing evolution of the inner logic of the default norms for risk allocation towards an increasingly conscious logic of risk management.

Naturally, contractual risk management has its limitations and, as the first phase of the theory suggests, the usefulness of contractual risk management is limited by the general strategies of risk management and the policies of the contract parties. Consequently, the availability of non-contractual tools of risk management will limit the application of contractual risk management as long as that is cost-effective. Regardless, the contractual risk management approach will presumably offer a common language for the three dimensions of commercial decision-making: economics, legal and social, as well as for the professionals representing those dimensions. The common language will hopefully provide non-legal professionals with an insight into contract law and illustrate the fact that the legal approach to contracts is not only a ‘legal-risk’ but also a resource for risk management. For contract consultants, the awareness of the contractual risk management approach will hopefully provide an opportunity to refer to the theoretical framework as an aid to their pragmatic and ‘encyclopedic’ working methods. For judges, the introduction of the theory of contractual risk management will presumably provide evidence of a higher rationality in the contractual allocation of risks by the contract parties than what has been expected, which in its turn suggests that judges should be particularly careful when adjusting commercial contracts and focus on the procedural reasonability of commercial contracts in terms of reasonable contractual protection of the contract specific investments.

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Updated 20.02.2001