How to Manage Contracts
Contract management seems like a daunting undertaking when faced with scattered files and missing spreadsheets. The financial benefits of contract management are worth the effort. This article provides a roadmap to get your organization from messy to managed.
To manage contracts effectively, it is important to embrace three basic principles. These principles ease the transition to contract management and help deliver more value from the contract portfolio.
Principle 1: A Contract is Not a Document
Certainly, most business contracts are reduced to writing and are therefore a document. A contract, however, covers the entire legal relationship between you and the other party to the transaction. Even simple contracts often consist of more than one document.
For example, the contract might contain the main agreement, a related Non Disclosure Agreement, a Schedule, and an Amendment. All of these documents are important to understand the contractual relationship.
Principle 2: The Contract Portfolio is more than a List of Contracts
Organizations often manage contracts on a case-by-case basis. This approach misses important commonalities and risks that are common to contracts.
One of the hallmarks of effective contract management is the ability to see commonalities and risks across contracts without having to read each contract. It is useful to classify contracts correctly, to identify those with legally significant provisions, and to link contracts to counterparties.
Principle 3: Contract Risk is Measurable and Manageable
You can begin to apply principles of legal risk management to further improve and optimize financial performance once the contract portfolio is in place. The contract portfolio provides data about the likelihood of certain risks because you can measure the number of contracts containing the relevant provisions or signed with the party in question.
With those principles in mind, it’s time to start managing contracts. Let’s break the challenge down into three phases: 1. Get organized, 2. Capture important details, and 3. Analyze and control.
Phase 1 Get Organized
There are two steps to organize contracts when you do not have any system in place.
Assess the current situation
These questions will help get you started:
- Are there any spreadsheets listing contracts in your organization?
- If so, how many? Is there one centrally managed spreadsheet or does each department or group keep its own spreadsheet?
- Where are contract documents stored? Are there paper files or all contracts stored electronically?
- If documents are stored electronically, are they stored in a central location, different drives or files, or on individual computers?
- What is the scope of your contract management effort? Are there important limits? For example, are you only tackling expense contracts, but not revenue contracts?
Answers to these questions will help you gauge the size of the project. You are driving toward a central repository: every contract in one place. To accomplish that objective there needs to be one spreadsheet with every contract listed which is within the scope of your project.
It is also important to link the documents to the right contract. We cover that in Phase 2 Capture Key Details.
Create a Classification System
Contract management leverages several classification schemes. Start by classifying contracts. The trick is to develop a list of contract types that is neither too short nor too long.
Classifying contracts merely as “Revenue” or “Expense” is probably too simplistic for most organizations. Although tagging a contract as revenue or expense is quite useful.
Contract schemes with thirty different types and subtypes sprinkled in are impractical for most organizations and effective reporting. Target 5 - 15 types of contracts at the start. Your list might look something like this:
Confidentiality Business Development Employment Equipment and Supplies Financing Information Technology Real Estate Sales Service
The next classification scheme to consider relates to documents you will manage. Remember, contracts and documents are not synonymous. There might be significant variation between organizations, but here is a list to get you started:
Addendum Agreement Amendment Correspondence Insurance Certificate Invoice Letter of Intent Memorandum of Understanding Other Permit / License Purchase Order Schedule Statement of Work Subcontract Work Order
The list of document types should be grounded in your business practices and contracts.
Now that you have assessed the situation, collected your contract data, and classified your contracts and documents, you are ready for Phase 2 Capture Key Details.
Phase 2 Capture Key Details
Collect consistent data about each contractual relationship. Not every contract is the same, but the kinds of data we can collect about contracts are strikingly similar. Here are facts you can probably gather about each contract in your portfolio:
The parties to the contract are the people or companies with whom you are signing the contract. Parties are also called Counterparties generically. Most contracts involve only one other party, but multiparty are not unusual.
Choose the contract type from the classification list you created in Phase 1. If the deal is a Non Disclosure Agreement, then you would mark the contract as a Confidentiality type of contract based on the classifications above.
This is not essential, but later you might appreciate a 5-15 word description of the contract for easy reference.
You might want to track the legal entity in your corporate family that is signing the contract. This entity is different from the Party above. Imagine that you have a parent company (Parent Co, Inc.) and Parent Co, Inc. owns SubCo A and SubCo B. If SubCo B signs the contract with the other Party, then you might want to flag the contract as between SubCo B and the Party.
Some organizations also like to track the Department handling the contract.
It is often useful to have semi-structured data in the form of tags to designate contracts as revenue or expense related. Or you might mark them as related to business unit or geography.
Comments on the contract are often useful, provided they are current and it is clear who made them.
It is imperative that you capture the effective date and the expiration date of the contract. Some contracts do not have an expiration date because they are evergreen or auto-renewing. Tracking those is especially important.
It is tempting to think that tracking contract amounts is an obvious detail to capture. It might be. However, contract payments and amounts owed are best left to accounting systems. Even technical connections between contract management systems and accounting software (Application Programming Interfaces or APIs) can generate more questions than answers.
The second issue with contract amounts is that a single value is hard to determine when there are formulas, payment schedules, or contingent amounts.
If you want to track amounts, consider just a high level value for bucketing the contract.
Phase 3 Control and Analyze
Now that you have all your contracts in one place and a basic set of data about each contract, you can begin to control and analyze those contracts.
The reporting and analysis each organization needs will differ. Here are some questions you might answer based on your newly organized contract registry or portfolio:
- What contracts expire in the next three months? Bonus: which of those have auto-renewal provisions?
- How many contracts are in each contract type?
- How many contracts do you have with each party? Bonus: where is the contract amount is greater than (an amount you care about)?
- Which documents (not contracts) have indemnification clauses? Note: this might be hard with just a spreadsheet.
The bigger point is that you can now ask and answer questions about the collection of rights and responsibilities that cut across the entire collection of contracts in your organization.
Congratulations, you are on your way to better contract management!
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