Risk sharing occurs when two parties identify a risk and agree to share the loss upon the occurrence of the loss due to the risk. This is typically done in joint ventures (where equity owners share risks of the loss in proportion to their stakes in the venture), new ventures and relationships where each party shares actual operational control. Risks can be shared pro rata, pro rata in excess of a threshold, in sequential layers or a combination of these “pie-slicing” methods.
Risk sharing agreements are rare in outsourcing transactions. Where one party has physical control of the means of performance, the other party is prevented from exercising any control. The other party is thus prevented from acting to stop the loss. Further, outsourcing transactions typically involve repetitive business processes that are well-tested, commonplace, well understood and not inherently risky. However, outsourcing that includes some joint venture structure may involve such risk sharing arrangements.
Co-investors and joint venturers engage in risk sharing by defining the value of their contributions and limiting their future financial and performance commitments. In outsourcing, risk-sharing agreements are relatively rare because the paradigm follows the “fee for services” model.
Where the outsourcing is structured as a joint venture for legal reasons, the suitability of risk sharing agreements may depend on:
Complete Indemnification
One party could assume all liability for a defined risk under an indemnification provision.
Percentage Pro-Rata
Gains or losses could be shared pro rata in proportion to ownership or voting rights.
Excess over a Deductible
Liabilities could be shared only after they exceed a “deductible” amount.
Pro-Rata in an Excess Layer between a Deductible and a Ceiling
Treaty Reinsurance – All Risks of all Types for A Series of Transactions