The contract lifecycle: effective agreement management

May 2023  |  FEATURE | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

May 2023 Issue

Upon entering into a contract, trading parties should be under no illusion as to the nuances of the terms and conditions they are agreeing to – including the potential fallout of any contractual deficiencies – before signing on the dotted line.

Ideally, to avoid becoming compromised, parties should practice effective contract management: that is, the processes and procedures that companies may implement in order to manage the negotiation, execution, performance, modification and termination of contracts with various parties, including customers, vendors, distributors, contractors and employees.

Testifying to the necessity of contract management is the World Commerce and Contracting Association (WorldCC), which considers the discipline to be essential – particularly in a world where, according to the United Nations Conference on Trade and Development’s (UNCTAD’s) latest global trade update, the value of global trade was approximately $32 trillion in 2022.

“Trade and trading relationships are at the foundation of human society, enabling prosperity and driving social benefit,” states the WorldCC. “Its success depends not only on the continuous invention of products and services but also on establishing appropriate and innovative rules and practices and behaviours to govern the exchange of those products and services.

“We live in a world of rapid change,” continues the WorldCC. “The growing speed of invention, the greater diversity in the types of exchange that occur, and increasingly global markets have all contributed to a far more complex environment for trade. This turbulent environment has led to a need for constant innovation in commercial rules and contracting practices, which has in turn led to a need for far greater commercial competence and emotional intelligence.”

According to the WorldCC, there is growing awareness of the value that comes from excellence in contract management – an overarching discipline that, in many respects, is coming of age due to our connected world and the variety and complexity of commercial relationships.

Likewise, Helen Alder, head of product development and knowledge at the Chartered Institute of Procurement & Supply (CIPS), believes that contract management needs to be at the heart of a company’s supplier relationships, so that each party understands their obligations and those of the other party. “There are two parts to contract management, and each is equally important: the pre-award stage and the post-award stage,” she contends.

Firstly, the pre-award stage is any work that takes place prior to a contract being signed. During this stage, it is important to ask key questions. Why is the contract being established? How does it meet the needs of the business? Will the supplier be able to deliver? How will the contract be managed once it has been awarded? What are the risks if the agreement fails?

Secondly, the post-award stage is where contract management and maintenance come into play. Moreover, this stage can itself be divided into three stages: (i) service delivery, which means ensuring service is delivered with the agreed performance and quality levels; (ii) supplier relationship, which covers maintaining and developing an open and constructive relationship; and (iii) contract administration, involving formal management of the contract.

“It is essential that companies understand the scope of their contracts and categories of spend,” continues Ms Alder. “Every business is different, so a solution must be found that suits. Additionally, with a contract management strategy, companies can maximise the value of those contracts and minimise exposure to risk, thus improving delivery from suppliers and having better lines of communication.”

Clearly, companies should carefully consider both the pre-award and post-award stages of contract management – particularly for large-scale contracts that are high value and carry more risk. While a bad contract can cause a company to lose money, a good contract is likely to create strong, long term business relationships.

Overlooked

Despite the obvious importance of the contract management function, in many instances companies overlook the discipline, preferring to focus on what they believe to be the more ‘attractive’ aspects of a commercial relationship.

“Contract management is often neglected because it is not considered exciting work,” suggests Supply Chain Hub. “Many supply chain professionals would rather focus on the front end of the strategic sourcing process, such as research and analysis, networking, drafting the perfect contract and negotiating multimillion-dollar deals. However, the best negotiated contract does not mean much if it cannot be executed well.”

Another oversight in contract management is to focus too much on the contractor or vendor. As a general rule, contractors usually have an incentive to be successful in the performance of their contract because they wish to continue their business relationship and maintain a good market reputation – an alignment that can be further reinforced with performance-based compensation based on meeting milestones and performance metrics or penalties for missed targets.

There is also the issue that in the execution of contracts, specific performance expectations may not be met. These deficiencies, which can quickly add up and cost a company a significant amount of money, may not be identified.

“The risk of neglecting contracts is that a company may end up not getting what it specified, key goods and services will not be delivered, and supplier rebates may be missed on purchased goods,” adds Ms Alder.

While some may dismiss contract preparation as having little or nothing to do with the important aspects of the working relationship between contractual parties, there can be little doubt that contract management is one of the crucial activities in determining the success of any business arrangement.

Effective contract management

A key stage in the contract lifecycle is the implementation of an effective contract management system. This should identify and resolve all of the business and risk management issues associated with the contract as well as the underlying relationship between parties.

According to Thomson Reuters’ ‘Top Ten Steps for Effective Contract Management’, the following items should be considered by those tasked with negotiating, drafting, finalising and monitoring contracts.

First, investigation. Parties should investigate both the business and legal background for the contract and the proposed transaction and business relationship in which the contract is to be used, with appropriate representatives of the company interviewed to determine how the relationship has evolved.

Second, identification. Parties should identify the steps that need to be taken in order to comply with the requirements of any contract review and signature authority policies and procedures that have been established by the company.

Third, documenting the relationship. Once there is a good understanding of the scope of the proposed business relationship, parties need to identify contracts and related documents in order to document the relationship and complete any immediate transaction.

Fourth, time and responsibility schedule. If warranted by the complexity of the proposed transaction, parties should prepare a time and responsibility schedule for drafting, review, discussion, revision and completion of all required items and activities.

Fifth, negotiating essential terms. Parties should negotiate the essential terms of each contract and, if appropriate, prepare a term sheet or letter of understanding, to be sure that parties are in agreement before time and effort is spent on contract preparation.

Sixth, drafting a contract. Parties should prepare an initial draft of each of the required contracts and related documents or, in cases where the opposite party is responsible for drafting, review the initial draft of such items prepared by the opposite party.

Seventh, preparing for closing. Parties should prepare for the closing of the transaction, including pre-closing meetings and preparation of closing checklists and memoranda. If certificates or consents from outside parties are required in order for contracts to be finalised, they must be planned for well in advance.

Eighth, overseeing completion. Once all conditions to consummation of the proposed business relationship have been satisfied, parties should oversee completion of the closing of the transaction, at which time all contracts and related documents are executed and any required performance at closing is completed.

Ninth, closing documents. Once closing is completed, parties should ensure that all closing documents are organised and that copies are delivered to all interested parties. This is also the time to make sure that files relating to the transaction can be easily accessed in future should questions arise.

Finally, ongoing review. Working with company representatives, parties should establish a plan for ongoing review of the performance of each of the parties under the terms of the contract, at least in those cases where the contract is long term and calls for continuous performance over an extended period of time.

“If filing cabinets are overflowing and contracts are not being managed efficiently, such as missing deadlines and not having a grip on who your suppliers are, then it is time to find the right business system,” adds Ms Alder. “Systems can flag key deliverables and potential risks in the supply chain which are important considerations.”

Automation

In many cases, it is not enough that a company has professionals in place to handle contract management; rather, these professionals must be augmented with the presence of processes and software companions to satisfy increasing compliance and analytical needs.

“The main advantages of having a software system are the benefits that automation brings,” notes Ms Alder. “Systems will automatically flag expiry dates on contracts and which goods should be delivered and when – essential for most businesses, and especially for lean manufacturing processes where components are delivered just before they join the production line.

“Depending on the business and the appetite for development and automation, most companies are likely to have some basic systems in place,” she continues. “There are affordable solutions out there and most companies should strive to implement them so they can focus on procurement and supply chain strategy.”

Doing the right thing

While traditionally done through folder and file cabinet storage, this style of contract management is riddled with inefficiencies that detract from a company’s overall efficiency. In contrast, an automated service can help free up the many hours associated with managing a contract, thus creating more value.

“A well-drafted and agreed contract ensures everyone understands their obligations under the terms of the agreement,” affirms Ms Alder. “But a successful relationship is more than just following the letter of the contract, it is also about the spirit of the partnership.

“Innovative practices or more favourable payment terms allow for an investment in systems such as contract management software,” she concludes. “Doing the right thing means a supplier stays in business and a company continues to get the quality goods or services that it has worked so hard to source.”

© Financier Worldwide

BY

Fraser Tennant