Do you ever worry about contracts turning into a liability for your business? Contracts are critical for providing clarity and protection against risks, but if mismanaged, they can become a major liability, doing exactly the thing they are meant to protect against – putting your business at risk. Effective contract risk management is only possible if these lurking dangers are brought to light. And in this blog, we hope to do exactly that!
The average Fortune 2000 company has between 20,000 and 40,000 active contracts at any given time. Managing these manually, or with substandard, disparate point solutions is a gravely dangerous undertaking that can expose businesses to a world of risk. Manually managed contracts are fraught with errors and inconsistencies that can lead to heavy financial and legal repercussions. As per CLOC, the majority of teams dealing with manual contracts (greater than 50%) believe that AI-led automation can drastically reduce human error and minimize risk in contract management.
These errors and inconsistencies can range from missing important deadlines, inconsistencies in contract language, data entry errors, to potential legal disputes. Needless to say, none of these errors are inexpensive, but to shed light on the most serious lurking dangers in your contracts, we have prepared a list you should keep on top of your mind at all times.
Manage these top 4 Lurking Dangers for Effective Contract Risk Management:
Manual Errors in Contract Authoring and Review:
Manual errors are a common source of risk in contract management, and they can arise at any stage of the contract creation and review process. A very simple example of this is that a simple spelling mistake or inaccurate data entry could lead to incorrect pricing or delivery terms, potentially resulting in financial losses or disputes down the line.
To mitigate this risk, businesses can invest in tools that allow them to automatically author contracts and review them based on pre-set legal approved templates before any manual intervention for either.
The standardized contract language and version control offered by these automation tools can go a long way in making contracts fool-proof. Additionally, most tools offer features which enable configurable workflows that help streamline the entire review and approval process and make it easier for legal teams to review contracts authored by business stakeholders across the organization, minimizing exposure to legal risks and captures benefits for organizations.
Incomplete Revenue Recognition from Contract:
Revenue recognition from contracts can be a complex issue, especially for businesses that rely on manual processes. Incorrectly recognizing revenue from contracts can lead to financial losses, as well as compliance issues with accounting standards such as ASC 606. To manage this risk.
For businesses that use non-standard terms in their contracts, such as variable pricing based on usage or performance, it may be especially difficult to determine when revenue should be recognized. For example, if a company sells software with a usage-based pricing model, it may need to estimate the total usage over the course of the contract to accurately determine when revenue should be recognized.
Post-award analysis and tracking of a contract becomes essential here. Fully mature CLM solutions are tightly integrated with enterprise systems such as ERP, CRM, and HRMS. Configurable or context driven obligation fulfillment updates and contract utilization can be generated from these portals, helping teams to keep a close track of revenue recognition from complex contracts.
An Accenture report forecasts that by 2035, successful AI implementations can boost organizational revenues by up to 38%. Similarly, research from Gartner, Inc. Shows that nearly 50% of legal departments plan to rely on analytics for process improvement. More than a third of these departments will leverage analytics for legal analysis.
Unoptimized 3rd Party SLAs and Deliverables – Third Party Contracts
Contracts with third-party vendors can be a significant source of risk for businesses, especially when SLAs and deliverables are not clearly defined or monitored – which may be the case with large volumes of manually managed contracts. And without these clearly defined SLAs and deliverables, businesses may struggle to hold vendors accountable for meeting their obligations, which can lead to missed deadlines, poor quality work, and loss in value.
To illustrate this danger better, we will lean on an example. Let’s say a company has entered a contract with a third-party vendor to provide IT services. The contract includes service level agreements (SLAs) that specify the level of service the vendor is expected to provide, as well as the consequences if they fail to meet those SLAs.
However, many organizations can fail to properly optimize, track and enforce the SLAs in the contract as per the company’s specific needs. For example, the SLAs may not include penalties that are significant enough to incentivize the vendor to meet their obligations. Or the SLAs may not include specific metrics that are important to the company for tracking success, such as response time for critical issues. Without metrics, and optimization, tracking these SLAs to hold the third-party accountable is at best, a pipe dream.
This may involve negotiating with the vendor to modify the SLAs or seeking out alternative vendors who are better suited to meet the company’s needs. By taking a proactive approach to third-party contract management, companies can minimize the risk of contract-related issues and protect their bottom line.
Modern CLM tools such as Zycus Merlin have built in features that help automatically identify metadata and clauses and benchmark them against your organization’s best practices to highlight review scores at the contract level.
Data Security and Privacy Risks
Data security and privacy risks are also significant concerns for businesses that handle sensitive customer and employee data.
In fact, Gartner states that “Lawyers will need a strategy for adapting to new legislation faster than ever,” said Rastogi. “Understanding how their organization is exposed to new regulations, and how to evaluate potential disruptions will be critical for all organizations in the coming years.”
Societal pressures around privacy and the rapid evolution of artificial intelligence (AI) have forced regulators to move very quickly, and this will continue to be an open and risky area for contract managers to navigate in the near future.
CLM software with advanced security features such as role-based access controls, encryption, and secure cloud storage are a key first step into making the road towards data-privacy easier. Through tools like these, companies can minimize the risk of data breaches and ensure compliance with data privacy regulations such as GDPR and CCPA.
Conclusion
In conclusion, contracts can be a valuable tool for businesses, but if the hidden dangers lurking in contracts are not heeded then they can become an inefficient tool for managing risk and ensuring the intended value is delivered.
If you would like to understand more about how hidden dangers in contracts can be guarded against with the help of CLM software, click here to schedule a call with our solution experts.
