Contract Management: Risk Mitigation & Best Practices

Contract Management: Risk Mitigation & Best Practices

By: Robert Dickey

Contract Management - Is the process of methodically and efficiently managing contract negotiations, creation, execution, and analysis for the purpose of doing business while maximizing financial and operational gain and minimizing risk for the parties involved.

The best contracts are beneficial to all parties subject to the terms and conditions therein. A contract should provide both financial benefit and protect all parties from any and all harm caused by the other parties. A contract should be fair and equitable, concisely define and clarify any ambiguities, and set clear expectations for all involved. No one should walk away from signing a contract feeling like they got the short end of the stick. Following good contract management best practices will help avoid the typical risks from bad contracting.

The risks associated with poor contract management can include a variety of adverse situations including risks to your supply chain, financial hazards, legal jeopardy, security issues, or brand & reputation damage.

Supply chain risks can arise from not implementing strong contracts that bind companies doing business together to set expectations and requirements. Poor service from your vendors can create holes in your supply chain decreasing your customer service levels. Conversely, service level penalties against you as a supplier can directly impact profitability or be a drag on operational efficiency as you work to fix problems for your customer. Without the proper contracted terms and conditions your vendors can simply stop supplying or supporting you leaving you to scramble to find an alternative business partner, service or product, often under unfavorable conditions. I have seen customers walk away from inventory a company may be holding on their behalf simply because they could without repercussions.

Financial risks often categorized as credit, liquidity, asset-backed, and equity risk, are contract risks associated with the loss of money and impact to a company’s bottom line. From a contract management perspective, it could be caused by missing a key contract date such as a renewal, losing business, or inadvertently continuing the contract term due to an automatic renewal clause. Another example would be a contract termination or compensation associated with missed delivery dates, milestones, claims, or warranty problems. As mentioned above, service level penalties and excess or unplanned inventory can be a drag on profitability.

Legal risks arise when you have a breach of contract due to non-compliance with the terms and conditions or the potential for legal accountability and/or litigation. There are several types of legal risks including regulatory, compliance, liability, and dispute risks. Additional legal risk could occur from missing contract obligations and regulatory compliance requirements for things like HIPAA & Sarbanes-Oxley or to regulatory bodies like OSHA & the EPA. It could also be a result of intellectual property (IP) infringement, improper or lack of using the right legal clauses, confidentiality disclosures, and other contract disputes. Legal risk can also arise from third party lawsuits against the contracted parties due to negligence or defect in products or services sold to them.

Security risks can account for some of the highest profile and most severe consequences for your organization if not properly protected against. This is because security breaches with your contracts often result in additional financial, legal, and brand issues. When managing your contracts, security risks exist by storing contracts in insecure locations, allowing everyone with contract access to have the same level of access to sensitive contract data, leaving confidential contract data unencrypted, and by using email to communicate sensitive information. But it doesn’t stop there. Contracts should contain the appropriate information security clauses or exhibits and SaaS or cloud computing agreements if the product or service in question is software or IT related.

Brand risk is ultimately your risk associated with negative public and customer opinion about your company, product or service and is part of the aftermath of financial, legal, and security issues. Mitigating brand risk is more important than ever because bad news travels fast in today’s 24/7/365 ever connected digital world and can quickly impact your brand reputation. This, in turn, can impact your financial performance, employee morale, and the willingness of others to enter into business with you. Strong contracts built with integrity and fairness will go a long way in protecting your brand and reputation.

Contracts define business relationships for companies of any size in any industry. They are a pillar of strength for any organization from sole proprietors to the biggest corporations. This is why managing them effectively is critical to the success of your business. Whether you work in procurement, finance, legal, compliance, risk management, or sales, contract management has an impact on your daily work life.

Some of the most important elements of proper contract management include organizing contracts in one secure central location, tracking specific contract milestones, in-depth analysis & benchmarking, and using predefined contract terms, conditions and processes to avoid the use of inaccurate and non-compliant agreements.

The best practices addressed in this article focus specifically on the core components of solid contract management across the pre-execution and post-execution phases of the contract lifecycle.

If these practices are implemented successfully, your organization will be able to avoid many of the common dangers that can occur with substandard contract management. All of the aforementioned risks can be easily mitigated or even completely eliminated with a little patience, preparation, diligence, and attention to detail. Proper contract management will make your organization more efficient, provide an immediate boost in productivity, and most importantly, help mitigate your contract risk.

Use a central electronic repository specifically built for your contracts so they are easy to track, manage, and secure.

It’s not uncommon for organizations to store contracts in shared folders across multiple locations and formats. However, centralizing your agreements into a single electronic repository is an important first step toward effective contract management. It is essential for risk management, as well as the commercial success of your agreements.

Think about how often you or your team need to reference or find an existing or historical agreements, contract related communications, or drafts and iterations of the latest contract negotiation. Whether you’re locating a specific detail or reviewing the entire contract before a renewal or termination, there are many reasons why a centralized repository is a best practice.

Not only will it keep your agreements organized, it greatly reduces the risk of contracts being lost, overlooked, or accessed by the wrong people. It will also allow you to access needed documents at any time and if a contract manager abruptly leaves your company. If it’s an online, cloud based repository then access can be had anywhere on any device. Such ease of access and organization is not possible when storing a collection of paper contracts in various filing cabinets or a bunch of scanned copies scattered across multiple hard drives.

Contract management is very different than document management. Document management typically uses simple, unrelated tags and folder structures. When managing your contracts and contract related data, it is wise to develop a standard, common file naming convention. Having all your agreements in one location with contract specific file names it become easy to find everything and know where the latest drafts or information is. It is also wise to develop and keep a master file of all agreements and what state of their lifecycle they are in. A master list will show you how many contracts you have over all, how many vendors you have contracted, how much spend you have under contract, and any other pertinent data you want to track. Keeping a master list will allow you to quickly determine how many contracts are due to expire in the next week, month, or year. You can also conduct a full-text search on all agreements to quickly locate what you need, e.g. specific terms or clauses if you make them a field in your master file. ?

Avoid missed deadlines and realize cost savings opportunities by using automated alerts.

This best practice is key to managing financial risk for your contracts.

When you work with contracts, few things are more frustrating than overlooking an unwanted automatic contract renewal or failing to renew and finding yourself without a reliable, trusted supplier. Worse, you can find yourself negotiating at the last minute and needing to get something done without the ability to be patient or the leverage or competitive bids. It can cost your organization thousands, tens of thousands or even millions of dollars. Not to mention being locked into an additional term of an agreement you intended to terminate. You might also miss a certain condition that is activated by reaching a milestone in the contract term. Using your master contract file and setting up automated alerts, tasks, and calendar reminders is the perfect way to stay on top of these critical contract milestones.

Be sure to update all of your automated functions with new dates as you update, renew, or terminate contracts. You will also have the benefit of improved compliance by keeping an archived history of alerts and notifications for management and audit purposes.

Create a contract template and clause library with your company’s approved legal language, terms, and document formats to assemble contracts faster and eliminate deviations.

I cannot stress this practice enough. Nothing is more daunting and time consuming than drafting an agreement from scratch. When staff members are unsure whether they are using the proper and most recent language, major errors can be made. Your contract managers & negotiators should also know what terms, conditions, and provisions they can make concessions on. You should have plug and play alternative language for the clauses you find your perspective business partners tend to object to most. When your negotiators have a sense of confidence, rather than uncertainty, when it comes to authoring contracts they create better outcomes for your organization.

Creating a shared and collaborative template library is key to increasing the productivity of the contracting process, while mitigating risk. When your staff can leverage pre-approved language from a clause and template library, there will be no confusion about what language is most up-to-date and has the blessing of your legal team or resource.

Clause and template libraries help your staff assemble documents faster—while eliminating deviations from standard legal language that may open your company up to future litigation. Documents can be automatically formatted and styled based on the document type so that no manual clean-up is necessary. Creating a contracting standard operating procedure (SOP) document to go along with your templates will give your negotiators a guide to work from further eliminating uncertainty. Using a SOP document, you can apply your organization’s business rules around which clauses to insert under specific circumstances. For example, a contract over a certain value, say $100,000, can automatically trigger the need for a different Limitation of Liability clause. Or, a contract with a supplier in California may require a different Governing Law clause than one in New York.

Maintain version control of your contracts to avoid missing, duplicate, or incorrect data.

Keeping a contract “clean” throughout creation and negotiation is an extremely difficult task. In many cases multiple people in receipt of the document or parts of the document at varying times and they can all be making changes that may or may not be tracked properly. Try to lock your contracts down to only one person in your organization making changes to them. When two or more people could be editing the same document when only one should be doing so, how can you tell what changes to keep?

The key to success is to develop the aforementioned naming convention so it tracks changes by date and user. That way, you avoid missing, duplicating, or using inaccurate data that can result from emailing back and forth and comparing different versions. Any changes, comments, accepts, or rejects being discussed are seen in the latest version making the review process much faster. If you have a system that will accommodate it, you’ll also want the ability to “check-out” a document once it’s ready for signature. This prohibits anyone from making additional edits until it’s checked back in to the system.

Keep a full audit trail to ensure compliance and be prepared for an audit at any time.

Compiling the necessary records for an audit is extremely difficult when you have a decentralized system. This aspect of contract management has become especially critical since the enactment of the Sarbanes-Oxley Act and/or other industry specific regulations that apply to your business. When you’re using paper contracts, emails, and spreadsheets, ensuring that you have the appropriate version of each agreement is not always simple or fast. The best way to prepare for an audit is to consistently remain organized when it comes to your company’s records.

Having a centralized contract repository with a master contracts list and complete transaction & communication record tied to each agreement are critical to passing an audit. When you follow these best practices you develop systems built specifically to capture and store full contract history data such as tracked edits, updates, execution and termination dates, etc. which makes any regulatory compliance easier to achieve. It’s not a bad idea to set automated alerts on your calendar or in your contract management system to review your processes and workflows in preparation for potential audits. Making this more habitual, rather than rushed, stressful, and disorganized can save your organization a lot of pain in the future.

Automate your approval and signature processes to eliminate bottlenecks and improve the productivity of your staff.

One of the most time-consuming parts of the contract process is usually the approval and signature process. Those with sign-off authority are often the busiest and it can be difficult pinning them down for a signature. You can expedite the approval process by first, by spreading out the signing authority to multiple people with varying limits on who can sign what. You can set authority by category, complexity, or (most commonly) dollar value of a contract; giving lower level employees the authority to sign lower value or lower complexity contracts and non-disclosure agreements. We suggest limiting signing authority to Senior Manager level employees and above.

Next is to automate and digitize signatures. When a contract is ready for approval it should be set up in an electronic signature software system and emailed to the required signatories. If you do not already have an electronic signature platform there are plenty of low cost and even free software programs available. ?

Additionally, you can use e-signatures to get documents signed faster. This is especially helpful for those who travel or work remotely because you can get a signature in minutes, rather than mailing, scanning, or faxing a hard copy agreement. Another advantage of e-signatures is that they are more secure than paper or even PDF ones. E-signatures & e-signature software carry a digital record about who, when, and where a document was signed to ensure authentication and help with audit trails. Unlike emailed WORD or PDF documents, a document sent through an e-signature software program cannot be edited and additional clauses or terms snuck in by unscrupulous people. Fortunately, there are a plethora of options that are very inexpensive or even free. ?

Clearly define workflows for the entire contract lifecycle that simplify processes and improve compliance.

There are many moving parts and steps associated with the entire lifecycle of every contract. The greatest challenge you will have is ensuring that everyone involved in the contracting process adheres to all of the steps. It’s important to have well-defined and documented workflows for each stage of the contract lifecycle built using business rules and processes that team members find easy to follow. This ensures governance and compliance to your existing processes and can also enable optimized processes not currently possible when being handled manually.

You want engage with all involved to vet and create workflows that eliminate inefficiencies, multiple & redundant touches, and the need to manually track and facilitate each step. Contract management typically requires a request or need from an internal customer, sourcing & negotiations, contract draft, review, approvals, and execution of a final draft. Workflows can also differ by role, contract type, or by any data within a contract record. Automating as much as possible will help with these steps. Some of the other best practices like automated calendar reminders and email notifications will help accelerate your workflow processes.

Establish KPI’s and dashboards to help find and visualize the information you need, quickly.

Key Performance Indicators (KPI’s), reports and dashboards not only allow you to measure success but can also track productivity, so you can create better, more informed processes and business decisions over time. You will want to track things like total number of contracts, where they are in their lifecycles, estimated dollar value of each, priority, are they sole sourced, risk factors, and anything else you can think of that may be important to your business as it relates to contracts. Make reporting one of the most critical steps in your contract management process.

Nothing is worse than when something slips through the cracks and you have to scramble to get something done quickly so ensure service or the continuity of your supply chain. And dashboards take your valuable data and present it in a graphical, user-friendly format that makes it easy to discern and decide on needed action.

Reports can also help encourage collaboration by allowing you to distribute these processing metrics and KPIs throughout the business. In addition, you can capture and store a full contract history for auditing purposes.

Most importantly you will want to understand the impact a contract has on your business. You are going to put specific benchmarks and service level requirements into your contracts. Measuring the corresponding results as they relate to the contract are imperative. You will want to know if the contract made your company stronger either through the choice of supplier/customer, product, or service. Did it make you more efficient, save you money, or drive revenue. If so, how? If not, why? Can the contract be improved? Do you need a different business partner? Setting, measuring and understanding your KPI’s will result in better future contracts.

Standardize contract requests so you can quickly and accurately understand what is needed.

Many organizations employ inconsistent means of collaborating on contracts. Often times email, voicemail, or a hallway conversation are used to request contracts and relay the minimum amount of information needed by negotiators and legal teams to create them. This often leads to incomplete or incorrect information which adds unnecessary time to the equation. Additionally, not having all of the correct information can lead to not giving the ultimate beneficiary of the contract what they need or missed opportunities to provide them more value.

It is important to establish a standard and efficient process for gathering contract data. You want team members to quickly and accurately submit an existing contract, request the creation of a new contract, or if they have the authority, instantly create a simple contract (e.g. non-disclosure or pricing agreements) themselves with the use of a template.

A standard intake form or specific set of questions that feature pre-defined contract types, data fields, business rules, and workflows will be invaluable in this realm. Requesters and/or internal business customers simply populate all the information required for a contract manager or legal team member to produce a contract that meets your organization’s legal and accuracy standards and their needs.

Create standard, base templates and common clauses to work from.

Nothing is worse than slowing down your sourcing and legal teams with continuous back and forth red lines between them and the supplier. Knowing what you absolutely can and cannot live with is imperative to preventing this bottleneck. Having your legal team train your contract managers & negotiators the “why” behind each expectation will help them navigate the inevitable questions and/or push back from the other side of the contracts.

Draft contract templates that are mutually beneficial to both your company and your business partners to start with. One sided contracts are not only unethical but rarely get done quickly. Develop strong contract templates with alternate “plug and play” language that can be inserted where there may be clauses that could be deemed objectionable to counter any redlines but still meet your absolute must have needs. Keep the language simple and don’t balk when the other side wants to change a simple descriptor word that does not materially change the meaning, definition, or intent of the clause or contract itself. Make sure it’s something you can live with but maybe a little more favorable to the other side than your original language.

A good example of this is favored pricing. It never hurts to ask for the best possible price for a particular product or service in a particular market. Some would call this a MFN or “most favored nations” clause. If that is unacceptable to the supplier try to replace it with a similar clause that simply states they will give you the best price available as compared to other companies of a similar nature (size, market, company type, business transaction processes, etc.). This should ensure that you are at least in a good position as it relates to your direct competitors. Something similar to this:

Standard MFN:

“Competitive Pricing. Vendor hereby represents and warrants as of the date hereof and during the term of this Agreement that prices offered to Company with respect to the transactions made under the terms and conditions of this Agreement will be more favorable to Company than to any other Vendor customer. To the extent that Vendor is not in compliance with this section, Vendor shall refund Company the difference between the price paid and the lower price for each applicable purchase within thirty (30) days of determining that Vendor is not in compliance.”

Alternative Language:

???????????????“Competitive Pricing.?The prices, terms, and conditions under this Agreement must be as favorable or better than those offered by Vendor to any other similarly situated customer. To the extent that Vendor is not in compliance with this section, Vendor shall refund to each Purchaser the difference between the price Purchaser paid and the lower price for each applicable purchase within thirty (30) days of determining that Vendor is not in compliance.”

Providing alternate language that ultimately gets you where you want to be will show the party you are negotiating with that you are flexible and easy to work with. Creating an atmosphere or mutual collaboration will provide you and your company the best possible outcome with your contracts.

Conclusion. If you are someone who works with contracts on a daily basis, you understand the importance of adhering to best practices related to all phases of the contract management lifecycle. Once your organization has implemented a process and best practices across the pre-execution and post-execution phases, productivity is enhanced, risk is minimized, and profitability is maximized.

Keep in mind that all of these things can be done in any number of ways. You can organize your contracts in file folders on your network drive. You can use an intranet site like SharePoint or other online collaboration platforms. Depending on your organizations resources and budget you there are even very specialized contract management software programs available for purchase. If you opt for a contract management system make sure it has functionality that supports all of these best practices, is customizable and scalable.

These are the basics. However you choose to do it get organized, use these best practices and set your company up for success by mitigating its contract associated risks.