Why all the fuss about Contract Review?
Updated: Sep 9, 2022
Imagine, it’s 10 PM on a Thursday of the last week of the quarter and you get a ping from your CFO, inquiring about the status of multi-million dollar customer contract review pending with you.
Roll forward 3 days.
It’s 10 PM on a Monday and your CEO just called you to get a status on Force Majeure clauses in all your supplier and customer contracts in a major country experiencing political disturbances.
If you are a senior lawyer in a Fortune 1000 company or a Top Law firm, you have experienced this in some fashion, probably recently.
Contracts are the lifeblood of modern businesses. A typical Fortune 1000 company has anywhere between 20k & 40k active contracts at any time. A Mckinsey study estimates that substandard contract management practices erode business value up to 9% of annual revenues?! For the firms that manage the contracting process strategically, this is an untapped opportunity.
Fundamentally, managing contracts is about managing risk.
Whether it’s initial drafting, reviews, or negotiations with counterparties, you cannot always have your most experienced and domain expert legal mind attending to every case. So, when a relatively inexperienced contract professional, working under time pressure, not trained in rigorous contract management process starts managing the contract, typical mistakes creep in.
Missing key terms or clauses: as the adage goes, ‘out of sight is out of mind’, determining what is missing from a contract requires a broad exposure to the type of contract and business that is under consideration. While key clauses are never left out, there are many relatively ‘minor’ clauses or terms that are left unaddressed by the contracts and increase the risk for all parties
Incomplete due diligence: no one would accept this but many resorts to taking shortcuts to manage timelines. E.g., demonstrating ‘Blind Faith’ i.e. acceptance of another party’s claims and language without critical evaluation of potential risks and opportunities.
The best way to alleviate these risks is getting your most experienced set of eyes to draft and review every word. That is, of course, is not a scalable practice.
Force Majeure: one particular clause which had become the center of attention of lawyers and lawmakers alike, as Covid19 engulfed the world last year. A flurry of business insurance claim lawsuits & contract disputes hit the courts as everyone’s interpretation of ‘acts of God’, ‘government actions’, etc. differed. Over the last 18 months, countless hours have been spent debating and revamping contract terms like Force Majeure, causation, mitigation measures, etc. to ensure business continuity during such unpredictable times. If there is one lesson for contract management practice from 2020, it’s to never leave anything to chance.
Beyond the unique nature of issues brought by the pandemic, there are many examples where individuals and companies ended up with bad and sometimes catastrophic consequences because of lack of rigor during the contracting process. Let us look at two such examples:
How much can a single comma cost? Up to 1 Mn Canadian dollars. The dispute was over the following sentence: “This agreement shall be effective from the date it is made and shall continue in force for a period of five (5) years from the date it is made, and thereafter for successive five (5) year terms, unless and until terminated by one year prior notice in writing by either party.” Can you spot what the interpretation issue was? Read the entire story here.
How closely are you reading the limitations of liability clauses? In one famous case of Obsessions in Time, Inc vs Jewelry Exchange Venture, LLLP, everything came down to how Florida state courts analyzed the exculpatory provisions in a lease contract and ruled in a $ 2 Mn burglary claim. The parties’ lease agreement for the storage of Obsessions’ valuables provided: . . . it is hereby agreed that lessor [Jewelry] . . . shall not be liable for any loss or damage to the contents of the vault within the premises caused by burglary, fire, or any cause whatsoever, but that the entire risk of such loss or damage is assumed by the lessee. The lessor shall not be liable for any delay caused by failure of the vault doors to lock, unlock, or otherwise operate, and the sole liability of the lessor hereunder is limited to the exercise of ordinary care to prevent the opening of said vault or boxes contained therein by any person other than lessee [Obsessions] or the authorized agent of the lessee. The Appellate courts disagreed with the trial court’s observations and ruled in the lessee’s favor. This is a classic example of how treating key clause terms and provisions in a ‘standardized’ fashion can lead to unforeseen outcomes down the line.
A combination of factors like increasing business complexity (supply chains, stakeholder relationships, customer’s demands), ever-increasing business expectations from contract managers, and tail events like Covid19 have demonstrated one thing very clearly — that treating contract management as a cost center and not a potential driver of business value is a mistake which no business can afford.
Businesses should invest in the development of contract analysis and management practice through a combination of training, process thinking, and the use of technology (especially Machine Learning technologies like Natural Language Processing).
In our next article, we’ll discuss how leading companies have developed systematic approaches towards the contracting process and where this world is headed.