Why Contract Management?

Articles about Process | Contract Types | Parties | Risk Management | Professions Contract management benefits every aspect of the organization's financial performance. Recurring revenue management provides stability. Expense control helps the bottom line. Effective contract management is critical for organizations that want to optimize operational and financial performance while mitigating risk. So much time and effort are spent to ensure that terms are drafted and negotiated to maximize benefits and minimize risks, but too often these carefully crafted contracts are simply filed and forgotten. Contract management is primarily a reactive process for many organizations scrambling to resolve issues resulting from unmet obligations and performance requirements, missed deadlines, and lack of compliance with approval policies. Standardizing and automating the contract management process yields significant benefits to organizations small and large.

Risk management
At the most fundamental level, contracts memorialize what will happen when each party holds up its end of the bargain and, also, what will happen if either or both fall short of their commitments. Organizations usually manage contracts with the singular expectation that all parties will adhere to the agreement. It is typically not until after a requirement or obligation has been neglected that organizations begin to plan for how to deal with issues related to non-compliance or breach. Rarer still is the organization that proactively monitors events with the objective of steering things back on course before non-compliance ever becomes an issue. Despite the significant financial and reputational risks from the disputes and litigation that result from breaching a contractual obligation, many organizations have little in the way of preventative processes and systems when it comes to managing contracts. After all, a single contract may have numerous requirements for both parties and even small to mid-sized organizations often have dozens, hundreds, or even thousands of contracts (large organizations commonly manage tens of thousands of contracts). If deadlines, deliverable requirements, quality and service level obligations, and special arrangements remain confined to a static document in a network folder or file cabinet somewhere, it is only a matter of time before human error turns into costly disputes or litigation. Sometimes the costs are straightforward, however painful, like a pre-negotiated penalty. Other times they have a way of multiplying, like the perpetual costs of reputational damage from failing to deliver on contractual promises to a customer.

Cost control

Efficient organizations are careful to negotiate various discounts, price guarantees, and caps on spending and increases when it comes to supplier contracts. But despite their very best procurement efforts, it is not uncommon for organizations to inadvertently undo many of the benefits written into their supplier contracts.

Discounts contingent on order volumes or payment timing are missed due to lack of consistent communication between sales, finance, and billing personnel. The window of opportunity for optional renewals with locked-in prices passes simply because there are too many contracts to monitor across the organization. Spending often exceeds contractual caps because there is no clear and easy way to verify whether or not the right approvals have been given.

Drafting a contract with detailed and thoughtful terms designed to minimize expenses does not do much good when post-execution management of the contract lacks the same level of rigor.

Revenue optimization
Incentives, pricing options, and conditional fees are just a few of the many ways that contracts provide significant revenue opportunities. However, much of the time contracts are implemented with the agreed base pricing and terms and little is done to ensure that conditional revenue opportunities are remembered or acted on in the future. Consider the following typical scenarios:

An early renewal option guarantees that the contract will continue at the current favorable pricing, but the sales representative responsible for the customer recently left the company and has not yet been replaced. Incentive bonus payments are available for early completion of project deliverables, but the project manager is only aware of the committed deadlines. Favorable pricing terms are contingent on minimum quantity orders, but the billing department only adjusts prices when the customer service representative notifies them of the orders under the minimum.

Too many organizations are caught unprepared by these sorts of scenarios, losing revenues simply because they do not have effective processes for consistently managing the various terms that impact revenues across all of their contracts.

Effective contract management

Enabling organizations to effectively manage the risks, benefits, and costs stemming from their contractual relationships requires systematic processes for making the right information easily and securely accessible, proactively monitoring contract performance and compliance, and timely notifications and reporting delivered to the right people. A robust contract management system

standardizes and automates these processes to ensure that static contract documents become dynamic tools for avoiding risk, maximizing revenues, reducing costs.
o o o o

Instantly locate the contracts and all related documents you need in a central and secure repository with powerful search capabilities. Streamline and permanently document contract approvals with a system customized to your processes. Never miss a contract deadline again with automated alerts for everything from renewals to deliverable dates. Actively track performance milestones and compliance requirements with a central repository where everyone engaged in each contractual relationship can log and monitor key events.

Make contract management a proactive and systematic process in your organization resolving issues before they become unmet obligations or missed deadlines and actually realizing the revenues and cost reductions you worked so hard to negotiate.

How to Measure and Manage Legal Risk Part 2 Articles about Process | Risk Management | Professions How to establish a legal risk tolerance policy Legal risk is one of the most difficult kinds of risk for organizations to measure and manage. This article explains how to establish your organization's tolerance for legal risk. How to incorporate legal risk in your risk management strategy with ISO 31000. What is your legal risk tolerance? When it comes to legal risk many organization implicitly adopt a "zero tolerance" policy. Unfortunately, "zero tolerance" does not create zero risk. The zero tolerance preference is counterproductive, because it leads to the misallocation of precious risk management resources. This article outlines how to establish a risk tolerance policy within your organization's context so that we can better measure and manage legal risk. What is a legal risk tolerance policy? Put simply, a legal risk tolerance policy is an explicit acknowledgement of the level of risk and types of risks that an organization will accept with little or no treatment. Risk is the "effect of uncertainty on objectives" under ISO 31000, see How to Measure and Manage Legal Risk Part 1: How to Define Legal Risk. The effects of legal risks can be sweeping. ISO 31000 allows us to include a variety of consequences in our risk calculation. While some important consequences are not financial, this article focuses on the financial aspects of legal risks for two reasons. First, financial examples illustrate the process of establishing a risk tolerance policy. Second, people charged with managing legal risk - lawyers, contract managers, and the like often struggle to communicate the value of preemptive legal risk management to the organization. Why is risk tolerance important? An explicit legal risk tolerance policy achieves two objectives. First, it saves the organization money by calibrating the cost of risk treatment under ISO 31000. The

organization cannot know how much to spend on preventative risk management if it does not have a target for acceptable risk. Second, the legal risk tolerance policy improves organizational efficiency. For example, it is not unusual for sales executives to complain about revenue deals held up in legal. If both sides understand the organization's tolerance for risk, then sales executives and lawyers can collaborate on the contract in a meaningful way. How to plot legal risk events? To illustrate the role a risk tolerance policy plays, we will plot ten risk events. This image presents the risk events graphically.

The vertical scale (Y axis) measures the consequences in financial terms. Apply the multiplier appropriate for your organization: 100's, 1,000's, or 1,000,000's. The scale is arbitrary, adapt it to your risks and organization. The horizontal scale (X axis) represents the probability as a percentage. A precise measurement of probability for legal risks is quite difficult for most organizations. However, using probability instead of likelihood better clarifies risk tolerance. A subsequent article will discuss how to determine the values for consequences and probability. The size of the risk events (circles) is the product of the consequence and the probability for each risk. Notice, for example, that the far left risk is smaller than the far right event, even though the financial loss (consequence) is potentially almost double. The reason is probability. True, this event might cost the organization $800 (or $800,000 or $8,000,000, etc) but there is a less than 5% probability of the event. The risk event on the far right, on the other hand, is almost 80% likely to occur. The risk is greater. With the risk events plotted, we can examine three different approaches to risk tolerance. Imagine that three companies face identical risks, but each company has its own risk tolerance policy. Company A: Low risk tolerance Company A has a low risk tolerance policy. Any event above or to the right of the sloping line represents a risk that Company A will actively prevent or treat. Conversely, events to the left or below the line are "tolerable," meaning that the organization can absorb them financially and culturally.

If the company can tolerate about $150 (or $150,000 or $1,500,000 and so on) in losses, then we draw the line between acceptable and unacceptable risks as shown. In this example, then there are three tolerable risks. Risk tolerance is a guideline, not a bright line, as demonstrated by the line splitting some risks. Company B: Medium risk tolerance Company B can tolerate slightly more risk. Company B can endure about $210 in risk and draws the line as shown.

Company C: High risk tolerance Company C, however, demonstrates a much higher level of risk. They draw the line at about $760 in losses.

At first glance, Company C looks foolish. More than half the identified risk events will go untreated or receive little management time. However, context matters. There is much we do not know about all three companies. What level of risk tolerance is best? Which of the three companies adopts the best risk tolerance policy? Here, ISO 31000 shines. The answer, of course, is that it depends on the context. Context in ISO 31000 comes in two flavors: external and internal. ISO 31000 gives organizations wide latitude to design what is relevant context. External context can include, for example, cultural, social and regulatory factors as well as relationships with stakeholders. Internal context covers strategies, objectives, capabilities and contractual relationships, among other factors. The context is important, not as an abstract concept, but to help us define the organization's risk criteria. Risk criteria Risk criteria allow the organization to evaluate and compare risks. The cost of risk treatment is measured against the level of the risk with the risk criteria. Risk criteria impose consistency on how an organization identifies and measures each element of a risk. In the examples here, there are only three risk criteria: 1. Likelihood is measured as a percentage probability, 2. Consequence is exclusively a financial loss (not a profit), and 3. Risk is the product of the two with no other considerations. In other words, these examples are not realistic because they ignore factors that organizations consider all the time. Cost of risk treatment These examples do, however, highlight an important element of a risk management strategy: the cost of risk treatment. Company A might claim that they "cannot afford the risks" above the line, but it is not clear that they can afford the risk management required to draw line left and down. As a simple example, Company A will have higher (maybe much higher) insurance costs. They will purchase coverage for more events at higher coverage amounts. For risks that are not insurable, Company A will invest more in technology, training, reporting, management oversight. These investments can reduce investments in revenue generating activity. How to set risk tolerance policy? While it is true that risk is about more than just money, it is important to clarify risk in financial terms. It is possible to criticize ISO 31000 as opening the discussion of risk too broadly to justify almost any or no action. This criticism is ultimately unfair. When it comes to legal risk, in particular, it is best to measure the financial implications of risk. We can then turn our attention to cultural and political considerations. Legal risks in a financial context Legal risks are rarely viewed collectively and even less frequently in the context of the organization's financial objectives. Risk managers, contract managers and lawyers often view no legal risk as tolerable. Sales executives and business leaders often just want to "get the deal done." How does an organization balance these opposing views? The risk tolerance policy is critical. But how do we pick a number (assuming for the moment this narrow focus on financials)?

Recall that ISO 31000 defines risk as the effect of uncertainty on objectives. Organizations, departments and teams all have objectives. Let's use the highest level for discussion: the five year strategic plan, particularly the financials. The strategic plan Here are hypothetical (simplistic and likely unrealistic) projections for a five year strategic plan. The plan results in an annual increase in revenue of 4% and a reduction in expenses of 4%. The organization wants to move from a slow growing company with 5% operating margins to a growing organization with 36% operating margins. Each part of the organization is responsible for various components of the plan to achieve those objectives.

Apply the risks to the plan Let's assume that for each year of the plan the identified risks can reduce revenue by just 0 - 5%, after the planned growth. For example, key sales contracts might get renewed or a major distributor is lost. Let's further assume that in each year risks impose between 0 5% of addition costs, after the planned reductions:

Price increases occur despite the contract, because no one monitors the contract adequately, Regulators deem warranty contracts are actually insurance policies imposing regulatory fines, and A key vendor defaults and a replacement vendor is expensive on short notice. One scenario is illustrated here:

The cumulative effect of these risks would reduce the company's valuation by 21%, assuming valuation is based on a 5.0x multiple of EBITDA.

The first scenario shows just the effect of expense related risks. The second scenario shows the effect of both revenue and expense risks on corporate valuation. This context allows us to measure and manage legal risks that are important to the organization. What ist he value of legal risk management? The examples in this article are artificially precise by design. They meant to illustrate a method of establishing a consistent, useful legal risk tolerance policy. With that policy in hand, we can calibrate risk treatment measures and communicate the value of legal risk management throughout the organization.

General Counsel and Contract Management

Articles about Risk Management | Professions Corporate counsel are critical to enterprise risk management for an organization. They must ensure compliance and provide quicker service to the business. Contract management software helps corporate counsel achieve these competing objectives. The role of corporate counsel has evolved to include responsibilities for risk management and business leadership. The demands on corporate counsel are diverse and unrelenting. Organizations are reluctant to increase corporate counsel staff. To meet the demands, corporate counsel must identify risks earlier while providing more value to sales, operations, finance, and the executive team. Busy corporate counsel manage hundreds or thousands of contracts of every variety: confidentiality agreements, licensing, employment letters, joint ventures, sales contracts, purchase agreements, leases, and M&A agreements. Every agreement has its own lifecycle, including amendments and renewals. Contracts that establish a framework for continuing business activity require continuous monitoring for compliance. Contract management software brings corporate counsel closer to the business, enabling better risk management and rapid response to new contract requests. Contract management software offers corporate counsel three benefits: 1. Establish compliance tracking 2. Accelerate contract turnaround 3. Advise executives about portfolio level risk

In house legal counsel use Contract Analyst to improve compliance and manage risk.

Covenant Tracking
Articles about Contract Types | Professions It is difficult to honor a promise you cannot remember making. Organizations easily forget the promises buried in the covenants of an agreement. Contract management software keeps the commitments present. Compliance tracking of contract covenants is a many sided problem. The counterparty has obligations to the organization; the organization, to the counterparty. Actions on both sides are either required, permitted or prohibited. Conditions in the contract and in the field can change the nature of the obligation.

Staff changes compound these legal complexities. New staff might not know about the contract, its history and requirements. Corporate counsel might not know that key staff have changed roles, so an expected listening post in the field goes quiet. Contract management software provides alerts to corporate counsel for potential compliance failures based on actual data. Corporate counsel can take a proactive, preventive role in contract management with early warnings of potential risks.

Strategic Agreements and Special Provisions

Articles about Contract Types Exceptional agreements require special provisions. It is imperative to track the nuances of contracts with substantial strategic implications for the organization. Unlike routine purchasing agreements, some contracts are one-time deals. They contain special or complex provisions. Joint ventures, merger & acquisitions, commercial real estate and many other transactions often contain special obligations that govern behavior over the life of the contract. Those complex provisions are difficult for staff to absorb into operations, but violations of the obligations can carry steep penalties or jeopardize the business relationship. Contract Analyst has the proven sophistication to centralize, distribute and notify key players in the organization about special provisions.