UNDERSTANDING RISK IN INTERNATIONAL PROJECTSJ. Kelley, Esq

2

THE PROBLEM

3

Risk is very difficult to explain

4

Understanding correlations between risk and mitigation elements is difficult and painful

5

Risk presentations either get mired in the details …..

6

Position DescriptionCustomers Rights On Contractor Delay Or Default.  

-Liquidated Damages: LDs are automatically assessed as follows: 5% up to x days late. Capped at X.-Default – If we cause a default, we will be subject to return of performance bond and advance payments, plus damages up to 80 percent of the contract value.-Consequential Damages – There are no express limits on consequential damages, meaning that we could be charged with loss of use or loss of profit.-Right of Repayment – The Customer may demand all money paid to us upon default-Indemnification Rights – Seller must indemnify customer for 3d party claims.-Third Party Property Damage/Death – If our system malfunctions and persons or property are harmed, we could be sued and those damages are not capped or excluded. We are not held harmless and the Customer does not bear this risk.-Withholding payment – If we default and the customer gives us notice, they may withhold payments to us (whether or not related to the default) and can offset payments against other contracts.- Bonds – Contract requires xpct performance bond and xpct advance payment bond. Either may be pulled upon default on demand. No liquidation.-Etc. 

Contractual And Other Limits And Defenses To Default

-Limitation of Liability – A clause in the contract clearly limits our liability to 80pct of the contract value. This limitation has been reviewed by counsel in the jurisdiction and covers default liability but not third party damages or liability.-Limits imposed by Legal Jurisdiction – The contract specifies the governing law as the law of the Kingdom of Saudi Arabia. Under Sharia law, contractual damages are limited to direct damages and our experts advise us that these are generally low.-Insurance Coverage- We have property damage and third party liability coverage under our xx insurance policy. The policy provides that xx, yy and the coverage deductible and limits are xx and yy. -Excusable delay – In the event of an excusable delay or a delay caused by the customer, we have the right to a corresponding delay of time but we need to make sure we provide timely notice.-Force Majeure – If there is a force majeure event, we are entitled to schedule relief but no monetary compensation for extra labor on standby. 

Performance Risk (Source- Program Manager And Engineering)

- Schedule – the schedule has plenty of slack and allows adequate time to build the system and account for any issues which may arise.- Technical Complexity – They consider this low risk because the system is low complexity and we have worked with all of the key suppliers before.- Acceptance – Acceptance is very well defined in the contract and the processes for getting final sign off are very clear and simple to execute.- Prior history with similar systems. – We have built and deployed a nearly identical system in xx and yy places in the past 18 months.Place of performance: The contract will be performed in our factory (supply build and assembly) and in xx country. We have performed work in that county for many years and know how to operate there. 

Dispute Resolution Risk The contract provides for Saudi Governing Law. Dispute resolution is via Saudi courts. There are pros and cons to this. A pro is that Saudi Sharia law provides limits on the amount of damages which will be assessed in a delay or default. A con is that Sharia law is much less predictable than western law. This may be modified somewhat by the fact that

Payment Risk Contract does not provide for our payment to be secured by the customer. We have not found any evidence of prior payment defaults, but have learned that the customer often pays slowly and recent events in the country suggest that there is at least some risk default. We requested a payment letter of credit but the customer refused to provide it. 

Third Party Injury/Damage

The contract carries a moderate risk of liability with respect to third parties. The following risk could arise in the event of …It would have been best if the customer had agreed to indemnify us against this risk but we do have insurance coverage. 

History With Customer We have done business with the customer for over 15 years and we have never had a claim or dispute lodged against us by the customer. Customer Claim/Litigation History

There are reports of recent suits by the customer against other contractors so things may have changed with new leadership at the customer. Our local counsel researched historical contract litigation and claims by this customer and discovered the following: 

Cash Risk During months 4-15, we project that we will have a 10pct negative cash position. Between months 18 and 24 we will also go significantly negative as we have to purchase xx. This significantly increases the risk of liability for default especially during those time periods.  

Profit Anticipated profitGrowth/Follow On Possible follow on in 2017, no budget yetCompetition 4 competitors. Newco, Bigco, Willco, and Lowco.Country Cost Of Doing Business

Tax regime – Difficult 

7

Or they utterly lack important detail …

8

Requirements Discussion

Customer/Government Furnished Equipment (CFE/GFE)

CFE requirements will be identified in bid assumptions.

Integrated Logistics No issues. Seller responsible until sell-off.

Property No issues.

Warranties System warranty length 12 months.

Licenses/Agreements/Royalties No issues. License costs included in estimated price.

Penalty Clauses No issues

Intellectual Property Will need strategy to ensure Seller retains all IP ownership rights for x product and Y product in bid.

Design/Production Efforts Contingent Upon Other Program(s)

No.

Bidding in Other Than Then Year $ No.

Economic Price Adjustment (EPA) Provisions

None.

Insurance – Casualty and Liability No issues.

Duties Seller responsible. Applicable costs included in price.

Hazardous Materials/Waste No issues.

Joint Venture No.

Consultants None.

Organizational Conflict of Interest No issues.

U.S. Government (RFP/RFE Require) Not applicable.

Contracts Slide from Actual Gate Review

9

Area Major Item

RFP

Contractual • Bid Bond: on-demand; 1% of bid value• RFP/Tender takes precedence over Bidders’ Terms

- bid exceptions/clarifications/assumptions need to be carefully considered

• Warranty: Extensive warranty coverage for 5-year warranty period + 2 more years for “latent defects,” as well as 25-year guarantee of spares & support availability

• Liquidated Damages: 1% of the value of the delayed item per week; max of 10% of Contract

• OGC Review Needed: - Country Law, Arbitration by GCC Commercial Arbitration

Centre- No express Limitation of Liability specified- No express exclusion of indirect/consequential damages

• IP / Source Code (needs OGC-IP Review): - Source Code (in escrow) is deliverable- Foreground IP rights vest in Customer

• Taxes: Contractor responsible for all local taxes (Working with Corp Tax to understand)

Financial • FFP, Direct Commercial Sale, $US or Euros• Liability, property damage, wokman’s comp insurance

Offsets 50% in Country w/liquidated damages if not achieved

Actual Gate Package – Contracts Slide

10

Managers, bosses, CEOs don’t understand what you are telling them

11

12

13

Which leads to ….

14

The “Dance of Hope and Denial”

I hope this clown

doesn’t drop me

Thank god she doesn’t know I

dropped my last 2 partners!

15

But if you don’t understand risk

16

You wont see what’s coming

17

Conceptualizing Risk

18

CONCEPTUALIZING RISK

What is Risk? Risk is the likelihood that something bad will happen

Your product doesn’t work, something burns up, your customer doesn’t pay, etc. The list is endless

Is there a Likelihood – Harm correlation? No! This means you have to think broadly about risk

Where does it come from? Risk comes from multiple places

Contract Terms Programmatic Factors External non program Factors

19

THREE TRADITIONAL SOURCES OF RISK

20

CONTRACT RISK

Risk can arise from any contract clause Default

Delivery Schedules

Indemnifications

Payment terms

Acceptance

Warranty

It can also arise from unclear contract clauses

21

PERFORMANCE RISK

Performance is a major part of risk Milestone Requirements

Supplier management

Shipment Risk

SOW and Spec Compliance

Development

Regulatory Requirements

Exim

22

EXTERNAL RISK

The Environment adds Risk International Taxes, Duties

FCPA

International Suppliers

War, Hostilities

Force Majeure

Distant Jurisdictions

Laws and Regulations

23HOLISTIC RISK

Contract Risk Programmatic Risk

External Risk

Default Milestones Taxes/Duties

Delivery Schedule

Development FCPA

Indemnifications

Supplier Management

Force Majeure

Payment terms Sow/Spec Compliance

War/Hostilities

Acceptance Export Import Sanctions

Warranty Shipment Dispute Resolution

Performance Bonds

Customer Relations

PM

Contracts

Supply Chain

Legal

24

MORE WAYS TO CONCEPTUALIZE RISK

25

THE NUKES

These can wipe you out Indemnifications

Third party liability

Consequential Damages

Color: RED

If you have nukes, you need to

Try and disarm them

26

CLUBS

The buyer can beat you up with these Performance Bonds

Advance Payment Bonds

Liquidated Damages

Strict Notice Provisions

Warranty

Color: RED - YELLOW

27

GRINDERS

Buyer can use these to wear you down Onerous terms -

Vague Acceptance Rights

Approval Rights

Inspection Rights

Test/Validation Rights

Color: YELLOW - RED

28

HOLISTIC RISK ASSESSMENT

What is holistic risk assessment? Holistic risk is looking at all the various pieces of risk and rating them and

figuring out how to mitigate them.

How do you assess risk? Don’t ballpark it because nobody will take you seriously.

You need to do your research – (upcoming slide)

Holistic risk is also about understanding how to negotiate and mitigate risk

And about convincing the right people that they own the risk

And you wont accomplish that unless you know how to brief it well so people understand

29

RESEARCHING RISK

Some places to research Risk

Research your customer Do they pay on time?

Are they litigious?

What terms have they accepted?

Have you ever worked with them previously? Have any of your subs worked with them?

Research the Jurisdiction What are the barriers to doing business there? http://www.doingbusiness.org/rankings

Research the Law Do they have rule of law? Are the courts fair? How long do disputes take to be resolved?

What are the tax laws?

Research the location Is the place of performance in a city, a mountain, a swamp?

30

OWNING RISK

Who the heck owns Risk? Does Contracts own it? Because of all the bad contract clauses right? Supply Chain? Because our suppliers might mess up? Finance? Because they price the contract right?

Its too risky to look at risk function-by-function A modest proposal:

The PM owns the business, so you have to get them to own the risk too. You cant separate risk from the business – they go hand in hand.

You and the other functions can help the PM manage the risk various parts holistically

31NEGOTIATING RISK

How do you negotiate risk? Work hard to clarify misleading or vague terms

Make sure contract is internally consistent

Win changes by understanding risk better than your customer

If possible, explain the effect unlimited risk may have on your price

Explain why certain remedies are overkill

Avoid competitions with boilerplate terms Coordinate your team

Make sure contract and supplier terms align so you don’t get “middled”

Get legal and accounting/tax help in the jurisdiction Don’t overlook the fact that risk is more likely to arise from problems in

performance than from accidental causes Read the SOW!

32MITIGATING RISK

The best time to mitigate is before award!

Mitigation is a team effort - Contracts Cant go it alone You need permission to push back on difficult terms

Need support from insurance team, supply chain and finance team and program management

Realistic mitigation plans can help reduce the fear factor - Consider a written plan?

Do your best with the contract terms – Try to get Limitation of Liability Clauses

Consequential Damages Caps

Payment Letter of Credit

Mitigation by Management Strong Contract, Program, Supply Chain Management can reduce risk

Programmatic Decisions and Factors can reduce risk High Margins

Strong Cash Flow Plan

Build Relationship with Buyer

Some risks may be incapable of mitigation

33

MITIGATION EXAMPLE

Issue: Difficult Jurisdiction/Venue Risk: We wont be able to move product because we don’t

understand the rules

Example: Moving goods/product in India

Mitigation: Work with local subcontractor with expertise in tax/shipment rules and flow risk down

34

MITIGATION EXAMPLE

Issue: Vague or Subjective Acceptance Criteria

Risk: We wont be able to prove we are done

Example: Upon completion of the test, the results will be presented to the buyer and if the buyer is satisfied, it will sign off on the acceptance certificate

Mitigation: Create a test plan with clear acceptance criteria and timing. Clarify objective “pass” criteria

35

MITIGATION EXAMPLE

Issue: Customer is known to pay late Risk: We don’t get paid

Practical issue: Are you really going to try and default your customer?

Mitigation: Require payment letter of credit. Design delivery milestones to keep you cash positive.

36

MITIGATION EXAMPLE

Issue: Product we are selling is designed to protect infrastructure. If it doesn’t work liability is high.

Risk: High risk accident could bankrupt company

Example: Airport scanner

Mitigation: Combine multiple mitigations: insurance, protective “hold harmless” clause from customer, consequential damage exclusions, LoL, and bidding entity insulation

37

BRIEFING RISK TO OTHERS

38

BRIEFING RISK

Risk and mitigation should be briefed together

How you brief risk is a matter of personal preference and what you think will work

Don’t overstate risk but don’t let important concepts be glossed over

Just be as clear as possible and use colors, categories, and consider visual aids to help understanding!

The risk mitigator is the hero

39

Briefing Formats…

40

Position Perspective Consequence

Indemnifications Very Very Bad Try not to give these – They may not be covered by the liability cap

On Demand Bonds Very Very Bad Puts too much control in customer hands

Third Party Liability Very Bad You need insurance or buyer indemnification. Very very bad if you don’t.

Onerous Terms Very Bad Boilerplate puts too much control in customer hands

Unclear Acceptance Criteria Bad+ -Very Bad Causes delays. Makes it hard to get paid. Opposite is good + or Very good

Competition Bad Lowers profit, makes terms really hard to negotiate

New Customer Bad Unpredictable relationship

Difficult Jurisdiction/venue Bad Everything is harder, more expensive, slower

Force majeure Good or Bad Moves to bad if it leaves you unpaid with work in process

Default Good or Bad You can perform, and have clear acceptance/payment criteria

Legal Regime Good or Bad Look for a fair playing field

LDs Good or Bad

Supply Chain Good or Bad

High Margins Good Gives cushion and greater risk tolerance

Arbitration Good More predictable outcome, faster

Payment Letter of Credit Very Good Lack of one makes everything else riskier, dependent on acceptance process

Cash Positive Very Good Great in a T4C or FM, moves to neutral if they hold on demand bonds

Liability Caps Very Good Limits all but third party damages. Lack of this increases all other risks

Consequential Damage Caps Very Good Takes loss of use, loss of profit off table. Opposite is Very Very Bad

Easy Product Very Good Much Less performance risk

RiskIncreasers

RiskMitigators

MY favorite – Color Table

41

Q&A Discussion Format?

Question Lower Risk Higher Risk

Can we do the work? Yes, this is old hat for us! We think so, but this is development.

Will we get paid? Yes, we have a payment LC We should, but acceptance criteria is poorly defined

How are disputes settled? Customer has default remedies plus on demand payment and performance bonds

Customer sends arbitration demand if parties cant settle dispute amicably

Etc. Etc. Etc.

42

Position Perspective Chance of occurrence

Risk Value Consequence

Onerous Terms Very Bad High Med-High Boilerplate puts too much control in customer hands

Unclear Acceptance Criteria Bad+ - Very Bad High Medium+ -High Causes delays. Makes it hard to get paid. Opposite is good + or Very good

Difficult Jurisdiction/venue Bad Medium Low-med Everything is harder, more expensive, slower

On Demand Bonds Very Very Bad Medium High Puts too much control in customer hands

New Customer Bad Medium Medium Unpredictable relationship

Legal Regime Good or Bad Low ?? - high Look for a fair playing field

Third Party Liability Very Bad Low High You need insurance or buyer indemnification. Very very bad if you don’t.

Default Good or Bad Low High You can perform, and have clear acceptance/payment criteria

Competition Bad Low Medium Lowers profit, makes terms really hard to negotiate

Force majeure Good or Bad Low Medium Moves to bad if it leaves you unpaid with work in process

LDs Good or Bad Low Medium  Predictable

Arbitration Good Low Pain reducer More predictable outcome, faster

Indemnifications Very Very Bad Low Very High If you give these you need a liability cap which covers them

Consequential Damage Caps Very Good Low Very High Takes loss of use, loss of profit off table. Opposite is Very Very Bad

High Margins Good N/A Pain Reducer Gives cushion and greater risk tolerance

Payment Letter of Credit Very Good N/A Pain reducer  Lack of one makes everything else riskier, dependent on acceptance process

Cash Positive Very Good N/A Pain reducer Great in a T4C or FM, moves to neutral if they hold on demand bonds

Liability Caps Very Good N/A Pain reducer Limits all but third party damages. Lack of this increases all other risks

Easy Product Very Good N/A Pain reducer Much Less performance risk

Chance of Occurrence?

43

TO: MY BOSS

FROM: ME

SUBJECT: NEW BID CONTRACT AND PROGRAM RISK

DATE:

This is an analysis of the contractual and legal issues which may present risk to the company and which may arise out of events such as inexcusable delay, nonperformance/default, or third party risks of the contract by SELLER.¶

1. Customers Rights on Contractor Delay or Default.

If we are responsible for a delay, or if we don’t perform the contract according to its terms, we are exposed to the following risks:

-Liquidated Damages: LDs are automatically assessed as follows: 5% up to x days late. Capped at X.

-Default – If we cause a default, we will be subject to return of performance bond and advance payments, plus damages up to 80 percent of the contract value.

-Consequential Damages – There are no express limits on consequential damages, meaning that we could be charged with loss of use or loss of profit.

-Right of Repayment – The Customer may demand all money paid to us upon default

-Indemnification Rights – RTN must indemnify customer for 3d party claims.

-Third Party Property Damage/Death – If our system malfunctions and persons or property are harmed, we could be sued and those damages are not capped or excluded. We are not held harmless and the Customer does not bear this risk.

-Withholding payment – If we default and the customer gives us notice, they may withhold payments to us (whether or not related to the default) and can offset payments against other contracts.

- Bonds – Contract requires xpct performance bond and xpct advance payment bond. Either may be pulled upon default on demand. No liquidation.

-Etc.

Color: RED

Memo?

44SUMMARY

Understand Risk Holistically Research it carefully Negotiate risk out of the contract

Establish risk mitigation measures for high risk items Tackle the high probability, high risk items first

But don’t neglect the low likelihood items which could have catastrophic effect!

Brief Risk with the Mitigations

The TOP questions to decide if a contract is too risky? “Can we execute this contract?” “Will I get paid”? “Do I trust the buyer”?

45