How to Use Contract Management and Software For Legal Risk Mitigation

In this article, Alka Singh discusses how to use contract management and software for legal risk mitigation.

What is contract management? Which companies need contract management and why?

Any business entity will enter into a large number of contracts as it grows. From the company’s side (if the business entity is a company), contracts could be drafted by the in-house department or external lawyers or law firms, and signed by the directors.

While directors may lead the project, day to day operations and implementation lie in the hands of company officers. Thousands of employees, managers and external consultants may be involved in the execution of the project.

Under any contract, there will be a connection between the business deliverables and legal obligations. As contracts not only take care of present obligations, but impact the company’s future planning, having an effective contract management process reduces risk and is a tool for planning and management of resources.

Contract management involves managing this translation of business deliverables into legal obligations and ensuring continuity of the relationship.

Efficient contract management processes can increase the likelihood of success of business outcomes, reduce risks and disputes.

Contract management ensures that legal documentation is up to date, which is a huge benefit in case due diligence is undertaken for an investment or other transaction.

Why does a company need contract management system?

For any large company, contract management can be a burden. Companies having a huge set of contracts will struggle with managing them, so they need to start creating a contract management system. It starts with identifying the framework and processes that need to be executed – these can be undertaken manually or through software (accuracy improves drastically with software, and any errors can have huge losses).

Standardization and Risk Uniformity

As companies grow, business models evolve, new verticals and product lines emerge, and the nature of the commercial arrangements differentiate. As a result, most companies deal with the huge volume of contacts having a disparate set of obligations. It makes mapping the quantum and sources of legal risk unclear. A manager or owner wants to identify specific situations in which there can be a risk, and it’s best if this set of situations is uniform across the same type of contracts and not inconsistent.

Thus, a company needs an ongoing effort to classify and bucket different relationships into categories and ensure risks within a contract category are consistent or uniform.

For a company, having different sets of obligations makes it difficult to plan and manage legal risk, which is why companies prepare standardized templates for contracts that are regularly executed and have narrow room for negotiation. Of course, some element of fairness or accommodation of the other party’s interest also needs to be undertaken. Otherwise, the risk of the deal falling apart is very high.

Historical Record for Reference to Past Incidents

Contract management software enables companies to create a centralized legal database which acts as a repository of contracts and documents. Apart from that, you can have a log of all actions taken pursuant to the contract (and even of exceptions that were approved by the other party) in one place, through a contract management system.

Software can be used to implement many features, such as ensuring confidentiality of contracts/documents by imposing access controls and limiting access to appropriate people within the company. For example, confidentiality clauses have standards such as a ‘need to know’ basis standard, as per which only people who ‘need to know’ certain information to perform their function will have access to it. This can be implemented through a form which is filled in by the person requesting the information, and which form can be approved on the merit of the request, by the relevant manager who has authority to grant access to others.

Evidentiary benefits of such a system are significant. If a case goes to court, you will be able to rely on the information contained in the printout of the logged events on the software (after certification by the person who manages data on the computer).

Smooth functioning of services

As legal validity and performance milestones are essential in many contracts, contract management softwares are made in a manner that they provide prior notice and automated alerts to appropriate people in the company in case of expiry, renewal or any other dates when intimation about achievement of milestones mentioned in the contract is to be made. Thus, contract management tools make it easy for smooth functioning of business as no important dates will be missed out.

Financial and Business Optimization

Contract management software act as a repository of agreements. Once the contract/documents are uploaded, the appropriate person who is responsible for making payment must be given access to the software which helps him to make timely and correct payment to the service providers. It ensures that all payments made have legal backing and that there are no defaults in payment when there is a legal obligation to pay. For example, if you need to make an annual payment for software, an intimation about when the payment is due will be valuable. In the absence of such intimation, if there is a default in payment, an automatic termination could terminate the license, disrupt the functioning of the software. If the software stops working, the business is impacted. While you can make the payment later, but additional effort and time will get wasted in contacting support teams in getting your software back up. This protects the company in case of any default in payment.

Ease of Various Internal Audits

Having contract management software in place, it helps in retrieving and sharing contract information quickly and effectively with the relevant parties.

Dynamic contract management software eases up audit of companies by having practical features such as organizing and storing approvals from different stakeholders (including authorized by the company) within the company.

Actions necessary to set up a contract management team in your company

Identify the objective sought to be achieved through contract management

Contract management can serve various business objectives. You will need to define for what purpose you want to use it. Questions to be answered for determining your objective are:

1. Will it be a repository of contracts or have more intelligent outcomes from it?
2. Which verticals will it be applicable to or used by? For example, merely for record-keeping by legal and compliance team or will they be relevant to operations (administration, purchase department, finance, marketing, product and IT) as well?
3. Do you want partial or complete automation of contracts? For example, will it just be for expiry and renewals or for all purposes of a contract, such as pointing out red flags (preliminary to a dispute), modalities of signing and negotiation, aspects of implementation (such as issuing new statements of work, tracking costs, internal approvals to take action under the contract, etc.).

Build a process to fulfill that objective

Processes will be based on the objective sought to be accomplished. Typical questions to be answered at this stage to frame a process are ‘who does what,’ ‘whose consent needs to be obtained for which action,’ ‘who has access to which information’ and rules for communication between different sets of people. Each set of people can have powers to view, comment or modify based on their permission level. Communication pursuant to these rules can be logged inside the contract management software itself.

Prepare standardized templates

In case a company has its templates and intends to execute these agreements as it is, then such templates can be uploaded on the contract management software with a brief explanation of the ‘key commercial features’ for the business teams, and placeholders where they can feed transaction-specific data (e.g., a specific expiry date) into the software. You may set a rule on what clauses can be modified and which ones cannot. Based on this, the software then allows people to fill in relevant data and upon completion, it stores executed the agreement.

Specify the features that must be tracked

Contract management software is made in a manner that it provides an automated alert in case of any agreement is about to expire of pending for renewal. The company has to keep the record of these intimations and act accordingly.

Select or commission a software to fulfill the above needs

Contract management software (“Software”) keeps the log of activity as to the people who accessed Software. This provided safety and security to the valuable company data and protected any data breach. Not every person in a company needs to be aware of every contract detail. Contract management software ensures that only the correct people in their organization have visibility into contracts, providing a secure central repository.

Internal contract creation cycle

To perform contract management effectively, you will need to be familiar with the internal life cycle of a contract in a company. Contract management is a process used to effectively manage and control contract lifecycle. While lawyers may be familiar with how to draft, negotiate, sign contracts and how to initiate disputes, when you are working in a company you will need to understand how a contract is initiated internally within the company. It is a long process. In smaller organizations the promoters or directors may simply sign the contract after going through it without much complexity. If necessary they may obtain their CA or lawyer’s approval. However, within a larger organization, the contract lifecycle is as follows (in this discussion, we are assuming here that a template for that type of contract already exists, otherwise legal will have to prepare one):

Contract Request (in case there is draft agreement is in place)

At times parties share their agreements which are already in place. In such scenarios, the contracts are reviewed by highlighting red flags. After marking of red flags, the negotiation process with the other party starts. There are software tools available which highlighted risk clauses and make the process quick for the author reviewing the contract. It is necessary to mention here that for the process of highlighting risk may differ from scope and purpose contract.

If a new type of contract is to be executed, which will frequently happen in an expanding business, a Contract Request (in case of fresh contact) is a first step in the life cycle of contract, upon receipt of request with scope, nature and obligations of the parties along with other relevant details drafting process starts.

This request is issued by the concerned business team who has a requirement. Once the Head of Legal and Compliance function (or someone else authorized by him), the finance controller (or its authorized person) and the concerned business head will approve the request, then the legal team will draft a standard template in consultation with law firms (if needed).

Approval from the Stakeholders

Every agreement constitutes operational (business) clauses and legal clauses. Operational clauses cover the scope of the agreement, purpose, and obligations of both the parties. The legal clauses in the agreement are not limited to disputes settlement and liabilities of the parties alone but extend to other clauses as well.

At the approval stage, in case of any clause found to be onerous for the company highlighted to concerned stakeholder for evaluation. Once the concerned stakeholder approves the agreement proceeds further for execution. The stakeholder will be Legal and compliance head (or it’s authorized person), finance controller (or its authorized person) and the concerned business head as the case may be.

Variables for which approvals are required

• Financial clauses of an agreement, including tax implications, are to be approved by finance team – example, payment cycle (e.g. payment date being 7th or weekly or fortnightly, tax (TDS, GST or other implications)
• Business risk clauses are to be approved by the senior business team which has initiated the request for creation of the contract (Marketing/Strategic Partnerships).

Example 1:

ABC and XYZ enter into an Application Programming Interface (“API”) Agreement, wherein ABC’s API is to be integrated with XYZ. Now, assume that there is a clause in the Agreement wherein it says that ABC will not be responsible to XYZ in case of any violation of intellectual property due to the use of ABC’s API. Now, it is ABC’s responsibility to prepare the API and XYZ is only to use it. It has not the ability to verify whether this is created by ABC or not (that is ABC’s responsibility). Therefore, ABC breaches another entity’s IP rights (say, by providing copied codes), consequences of the violation should not be on XYZ. However, since the agreement still says so, XYZ legal team will need to point out this as a ‘business risk’ to the business team (Marketing/Strategy Team’s appropriate person for their approval), else they will suggest an exclusion. They will not be lawyers and may not infer this risk by reading the agreement on their own. These clauses are often neatly tucked away or glossed over or even hard to interpret.

Example 2:

ABC and XYZ enter into a Marketing Agreement, wherein XYZ agrees to promote ABC products on its platform, and customers of XYZ will get benefits from the purchase of product. For this activity, ABC will pay to XYZ. If XYZ includes a clause mentioning that it will decide as to which customer should get the benefit, then this clause is onerous for ABC (because ABC has no way of choosing who is its customer through these benefits, even though it is paying for the cost of the marketing activity).

ABC legal team will need to point out this as a ‘business risk’ to the team (Marketing/Strategy Team’s appropriate person) for their approval, or suggest an alteration to this clause which enables ABC to incorporate its commercial objective as well. Since the business team does not comprise of lawyers, they may not become aware of this risk merely by reading the agreement on their own.

Legal risk clauses to be approved by the legal team in consultation with the business team.

Example:

In case of any agreement in between ABC and XYZ, there is a clause in the agreement that in case of default or breach of the agreement by ABC which causes a loss to XYZ, ABC will indemnify XYZ. However, nothing is stated about indemnity for a loss caused by XYZ’s conduct to ABC. As this clause is of a legal nature, it will be highlighted by the ABC legal team. The legal team may also give suggestions, such as altering it to a ‘mutual indemnity’ clause, where both parties indemnify each other in case of any loss caused by one party’s breach, to the other. Business team of ABC will then evaluate and give suggestions or negotiate the agreement. For example, Once business team approves the clause, legal team take it forward.

Execution of Agreements: Post negotiation and approvals from the relevant stakeholder the agreement proceeds for execution by the parties. This process may be done either manually or using online process. In India manual execution of agreements is prevalent. However, after commencement of Information Technology Act, 2000 and Information Technology (Amendment) Act, 2009 companies are inclined towards the execution of online agreements.

Database for Contracts: Once the agreements are executed, the contracts are stored. The storing of contracts made with incorporating relevant details of the contracts. The contract management software tools can be modified keeping in mind scope and nature of the contract. Once the contract is uploaded, appropriate people involved in implementation can use the contract.

How to select a contract management tool

Companies typically use 3 kinds of software for contract management:

• Standard ERP software
• Off-the-shelf software, e.g. Complinity, Demacq, Zycus, Practice league, etc
• Customized contract management software developed as per their need

Before you identify which method to deploy, you need to identify the functions which your software must be able to perform. After that, you can select any software which meets your needs. Irrespective of the type of software, functions of any contract management tool can be reduced to the following categories:

• Email communication and alerts for key events and actions (e.g. renewal, expiry, termination)
• Record-keeping and logging of events and approvals
• Grant or limit access
• Automatic red-lining to compare different documents

Software is useful or unnecessary depending on whether it performs the above functions on the metrics that matter to you. Results get enhanced further if:

• Analytics are provided for essential aspects to facilitate decision-making (e.g., X number of contracts expire and require to be renewed next quarter).
• Artificial intelligence and other techniques (OCR, programming, etc.) can be used such that the above functions are improved. For example, the software could automatically scan contract pages and detect dates for relevant clauses, or it could depend on the manual feeding of the same information. Some software tools scan and pull out specific clauses that will have the risk, such as indemnity, confidentiality, limitation of liability, applicable laws and applicable jurisdiction in case of disputes.

You may not be able to get the ideal outcomes from the beginning. Plus, what you expect from the software will alter your own experience and with business growth.

Thus, you will need to have an ongoing initiative to add more automation and reduce manual process through periodic upgrades. You can objectively substantiate your initiative by obtaining regular reviews of its working from stakeholders. Possible questions could be:

Indicative questions for working with the software

1. Is the software addressing the problems? How can it be improved?
2. Which functions are not being used?
3. Which functions need to be developed or improved?
4. Is it missing on tracking any material aspect of the contract? Can that be incorporated through an upgrade?

Indicative questions for improving business outcomes

1. Are contracts being renewed? Is data on the same being presented?
2. Do we need to send an additional communication to facilitate renewal?
3. Are payments being made on time?
4. What percentage of payments are being delayed and by how much? What is the financial cost to the company (e.g., cost at market interest rate for that much money)

This is relevant to you if you are connected with operations, finance, legal and compliance and in any other function where you deal with contracts regularly.

Don’t leave this alone to the tech team or the compliance team. If you are an in-house lawyer, you can consider this to be a part of your job. Engage with all potential stakeholders in an open way that enhances transparency and avoids risks that come from lack of communication and misunderstanding of contract terms.

It will improve company-wide results and thus indicate superior performance.

The post How to Use Contract Management and Software For Legal Risk Mitigation appeared first on iPleaders.