Legal Definitions - shifting risk

Shifting risk refers to the legal and contractual process of transferring the potential for a negative outcome, financial loss, or legal liability from one party to another. This transfer is typically formalized through agreements, contracts, or insurance policies, where the parties explicitly decide who will bear the burden if a specific adverse event occurs.

Here are some examples illustrating how risk can be shifted:

• Example 1: Construction Contract

  Imagine a city government hires a construction company to build a new bridge. Their contract includes a clause stating that the construction company is solely responsible for any cost overruns or delays caused by unexpected ground conditions, such as discovering unstable soil not identified during initial surveys. If such conditions arise, requiring more expensive foundation work and delaying the project, the additional costs and penalties for delay are borne by the construction company, not the city.

  This illustrates shifting risk because the potential financial burden and responsibility for unforeseen ground conditions are transferred from the city government to the construction company through the terms of their agreement.

• Example 2: Product Manufacturing Agreement

  A technology company designs a new smartphone but outsources its manufacturing to a factory in another country. Their contract includes an indemnification clause where the manufacturing factory agrees to take full responsibility for any legal claims or damages arising from manufacturing defects in the phones. If a batch of phones is found to have a critical flaw due to poor assembly, leading to a product recall and lawsuits, the factory is obligated to cover the associated costs and legal liabilities, not the technology company that designed the phone.

  Here, the risk of financial and legal consequences stemming from manufacturing defects is shifted from the technology company to the manufacturing factory.

• Example 3: Commercial Property Lease

  A small bakery signs a lease agreement to rent a storefront in a shopping mall. The lease specifies that the bakery (the tenant) is responsible for maintaining and repairing all non-structural elements within their leased space, including the HVAC system and interior plumbing. If the air conditioning unit inside the bakery breaks down, requiring costly repairs, the bakery is financially responsible for fixing it, rather than the mall owner (the landlord).

  This demonstrates shifting risk because the financial responsibility for maintaining and repairing specific parts of the property is transferred from the landlord to the tenant through the lease agreement.