Contracts are a vital part of every business. They serve as the foundation for the exchange of goods and services and outline the terms and conditions of business relationships.
Proper contract management allows organizations to ensure compliance, mitigate legal and financial risks, and maintain healthy relationships. On the flipside, poor contract management can cost businesses 9% of their bottom line.
Given the close business alignment necessary for effective contract management and the immense costs of poor contract management processes, it’s little wonder that 99% of corporate legal departments handle all or some of their contract management in house. Because of this, legal teams spend far more time on contracting than anything else.
To unlock their potential value, a foundational understanding of contracts must be established. Here’s a comprehensive overview of the meaning, types, elements and lifecycle of contracts.
Contracts are legally binding agreements. They outline the terms and conditions of the agreement (such as the goods or services being exchanged), the responsibilities and obligations of each party and the consequences of non-compliance.
While all contracts serve as the legal framework for an agreement, there are many different types of contracts; each with its own nuances to navigate. Types of contracts include:
Taking the discussion a step further, there are many types of contracts that are common to businesses which fall into one (or more) of the above categories. The types of contracts a business handles depend on factors like its size and industry, but some of the most common business contracts include:
Regardless of the contract type, certain parameters must be satisfied. To be legally binding, a contract must include essential elements such as:
It may seem that legally binding contracts have to satisfy a wide range of conditions – and they do – but so long as you understand the nuances of the contract type and your specific situation, this isn’t as daunting as it may appear. For example, a purchase agreement in which one party agrees to purchase goods or services from another party in exchange for payment is an enforceable contract.
Recent years have seen significant buzz around Contract Lifecycle Management (CLM) technology, but understanding the contract lifecycle and how to drive value through proper contract lifecycle management requires more than a tech tool.
Broadly speaking, there are five distinct phases of the contract lifecycle:
This phase involves collecting and organizing all relevant contract data and assigning resources. Relevant data may include counterparties, key dates, obligations, performance metrics and more; it should be entered into a centralized location for easier management and monitoring of the contract throughout its lifecycle.
Issues with contracting efficiency often occur during this initial phase. Many times, this is due to a lack of standard intake processes, decentralized processes or intake processes that do not support matter triage, allocation, status tracking or reporting.
The drafting and preparation phase is when contract creation occurs. One of the areas organizations often struggle with in this phase relates to creating first drafts – an issue that can be mitigated (in part) with templates and playbooks.
At this point, teams must be cognizant of the contract’s goal and scope in order to draft terms and conditions (such as delivery schedule, payment terms and other relevant conditions). The drafted contract must comply with relevant laws, regulations and industry standards, meet the requirements of all stakeholders, and include all necessary essential elements of enforceability.
During negotiation, parties align on the terms and conditions of the contract. If an organization has history with a given counterparty, they may be able to expedite the negotiation phase by accessing previous agreements.
If businesses lack standardized processes and legal escalation paths, they may face inconsistently negotiated terms or long contract cycle times.
At this stage, the parties have agreed to the terms and conditions of the contract, and those who are authorized to sign do so.
Some of the issues commonly seen during the authorization and signing phase relate to the lack of a signature policy (and in turn, lack of clarity on signing authority), or an inability to automatically manage performance obligations (and uncertainty around the final terms).
In this post-execution phase, the contract's performance is monitored. This includes reporting on key performance indicators (KPIs), ensuring obligations are met and updating the contract as necessary.
One of the most common issues in this phase comes down to businesses lacking a “single source of truth” -- a database where all executed agreements are stored. The impact of this shortcoming is clear. On average, 68% of contract professionals search for completed contracts at least once a week – once they locate the contract, they generally spend another hour at least finding the relevant section or language.
When organizations do have a database, it can streamline the negotiation phase, as it allows teams to easily find counterparty history (including counterparty profiles and previous agreements), in turn driving efficiency. Another critical element relates to reporting and analysis on topics such as most negotiated provisions; this information helps legal departments continuously improve contracting effectiveness.
The contract may be renewed or extended when necessary; otherwise, the contract is terminated (either because the contract term expires, the terms and conditions are violated or both parties agree to end it).
Lastly, contract dispute resolution is sometimes necessary. Paths to resolution include contract remedies (such as compensation), arbitration, alternative dispute resolution (such as mediation) or litigation.
When contract management best practices are followed, organizations enjoy benefits ranging from streamlined repapering and regulatory response to better business outcomes.
After optimizing contracting, we’ve seen clients enjoy results like:
Contracts are the lifeblood of every organization; most contract bodies hold immense (and untapped) potential value. Get in touch to learn more.