A subset of the legal risk; contract risk refers to the risk that losses may be incurred by an entity as a result of a counterparty’s failure to meet its contractual obligations. It may also result from an entity’s inability to meet its contractual obligations, subjecting it to penalties under the contract or legal disputes, etc. For example, the former source of contract risk may represent any potential losses arising from a situation where a buyer refrains from fulfilling the terms of a contract.

Contract risk may erode the value of a contract due to multiple reasons including miscommunication, bad planning and management of a transaction/ contract, deliberate contract manipulation, etc. This type of risk may also be caused by revenue leakage/ cost overruns (inability to get the most out of an entity’s services and offerings), failure of the contract to meet its business needs, lack of bargaining power (failure to act as an informed buyer), and so on.