Allocation of risk is central to all commercial contract negotiations. Each party to a commercial contract seeks to minimize its risk and maximize its reward, which creates an inherent tension between contracting parties. Parties can manage risk by carefully negotiating and drafting many common contractual provisions.

While all provisions in a commercial contract can be used to allocate risk, certain key provisions are commonly used as risk allocation tools. These include:

Representations and warranties are generally used to allocate risk by:

The broader the representation or warranty, the more risk is assumed by the maker. Makers commonly attempt to narrow their risk by:

For more information on how representations and warranties can be used to allocate risk in commercial contracts, see Practice Note, Representations, Warranties, Covenants, Rights and Conditions and Standard Clauses, General Contract Clauses: Representations and Warranties.

A well-drafted indemnification provision allows parties to customize their risk allocation by:

Each party benefits most by limiting its own indemnification obligations and expanding those of the other party. To minimize indemnification obligations, parties should seek to minimize the scope of the provision. Conversely, parties can also use indemnification as an exclusive remedy to avoid exposure to extra-contractual damages (including punitive damages).

Key factors contributing to the scope of the indemnity include:

For more information on allocating risk using indemnification provisions, see Practice Note, Risk Allocation in Commercial Contracts: Indemnification as Risk Allocation Tool.

For more information on drafting indemnification provisions, see Practice Note, Indemnification Clauses in Commercial Contracts and Standard Clauses, General Contract Clauses: Indemnification.

Limitation of liability clauses can be used to define the scope and magnitude of the parties' contractual liabilities. For example, parties can exclude liability for:

Limitation of liability provisions can be particularly valuable in commercial agreements where tort remedies, such as punitive damages, may otherwise apply. Parties should tailor a limitation of liability clause to meet their needs. For example, a limitation of liability clause may apply to:

For more information on risk allocation and limitation of liability, see Practice Note, Risk Allocation in Commercial Contracts: Limitation of Liability Clause as Risk Allocation Tool.

For more information on drafting limitation of liability provisions, see Standard Clause, General Contract Clauses: Limitation of Liability.

The provisions that make up a commercial contract's express remedial scheme can allocate risk by:

While courts have final decision-making authority in awarding remedies, contractual provisions defining the parties' intended remedies generally hold important evidentiary weight. Depending on the circumstances of the contract, parties can allocate risk by including or excluding contractual provisions that address:

Depending on the nature of the transaction and each party's contractual commitments, these provisions may be:

For more information on drafting contractual remedies provisions to allocate risk, see Practice Note, Risk Allocation in Commercial Contracts: Contractual Remedies as Risk Allocation Tools.

Any delay or acceleration of required payments impacts each party's available cash and risk of default. Parties can draft payment terms provisions to shift and manage risk by allowing payments to be either deferred or advanced.

Most commercial agreements involve some form of deferred payment obligation. With deferred payment terms:

Advance payment terms provide:

For more information risk allocation and payment terms, see Practice Note, Risk Allocation in Commercial Contracts: Payment Terms as Risk Allocation Tool.

For more information on drafting payment terms, see Standard Clauses:

Product warranties under the Uniform Commercial Code (UCC) allocate risk between:

Parties to commercial contracts can draft product warranties to allocate risk by:

For more information on risk allocation and product warranties, see Practice Note, Risk Allocation in Commercial Contracts: UCC Product Warranties as Risk Allocation Tools.

For more information on express and implied warranties, see Practice Notes, UCC Article 2 Express Warranties and UCC Article 2 Implied Warranties.

For more information on drafting product warranties, see Standard Clause, General Contract Clauses: Product Warranty and Disclaimers.

A force majeure provision allows a contracting party to mitigate its risk of breach due to events or circumstances it did not cause and could not have anticipated. Both obligors and obligees should carefully consider the scope of force majeure provisions because:

For more information on risk allocation and force majeure provisions, see Practice Note, Risk Allocation in Commercial Contracts: Force Majeure Provision as Risk Allocation Tool.

For more information on drafting force majeure provisions, see Practice Note, Force Majeure Clauses: Key Issues and Standard Clause, General Contract Clauses: Force Majeure.

Other common contract provisions that play an important role in risk allocation include: