01 October 2019
Digitally transforming contract management can help to improve compliance
According to the NASDAQ Global Compliance Survey, while companies are spending more to be adequately equipped to deal with regulatory changes and implementations, only 15% of firms feel fully prepared. According to NASDAQ, this can potentially leave firms exposed to both regulatory and reputational risk. The onus is on compliance teams to lead proactive efforts to ensure their firms are compliant both now and into the future.
One system that all compliance pros should be focused on when assessing their readiness is their company’s contract lifecycle management (CLM) system. Contracts, which govern every dollar in and out of an organisation, form the foundation of commerce and can provide a strong bulwark against compliance risk, as they define the terms of work in any relationship. In many companies, however, the contract management process is largely manual. According to LexisNexis’ recent report Legal Technology: Looking Past the Hype, only 26% of corporate legal departments are using a contract management technology solution to address this important area.
The challenge is that from authoring contracts to renewals, there are many different stages within the contract process that need to be carefully managed to address compliance issues. Organisations are tasked with overseeing an enormous array of contracts, each going back and forth over email, with multiple amends and questions sent between legal, procurement, compliance and sales teams; all forced to reconcile, negotiate and approve them as quickly as possible to keep the business ahead of competitors and shifting markets.
Meanwhile, the legacy contracts that need to be monitored to ensure compliance can slip off the radar. According to research by the Institute of Supply Management, the average Fortune 1000 company holds between 20,000 and 40,000 contractual files. Each contains multiple clauses and obligations – all of which if missed, can have a critical business impact.
Forward-thinking companies are starting to digitize this workflow to ensure speed while reducing risk and improving compliance. There are three key ways that a fully digital contract management system can help improve compliance in an organisation ranging from simple inclusion of key compliance terms in contracts to robust management of complex contract compliance issues.
For large companies, ensuring proper contract terms are included in a contract during the authoring process can be a time-consuming and risk-prone exercise but is absolutely critical in creating a strong, defensible framework against future claims. The challenge is how to work with teams worldwide without either slowing down the contract creation process or scaling compliance teams in unsustainable ways. Historically, the solution to this problem has been maintaining a group of contract templates that include pre-approved and up-to-date compliance terms. While this approach helps with the issue of scale, it does leave the company open to risk by entrusting employees to select the right contracting template for their situation.
Digitally transforming the contract management system can help compliance teams gain scale while also reducing the chance of human error by ensuring the proper language is included in every contract without relying on stakeholders (sales teams, buyers, HR pros, etc.) who may not fully understand the company’s legal requirements.
A simple example would be the application of contract language to address the US Foreign Corrupt Practice Act or the UK Bribery Act. A contract management software that allows a user to enter supplier data like location and then automatically selects the appropriate clauses based on workflow rules significantly reduces the chances that outdated or inaccurate language gets written into a contract.
Once the contract is assembled, a contract management system can ensure that the proper approvals are secured during the negotiation process. Best-in-class systems can manage the approval workflow regardless of whether the contract is on owned paper or third-party paper. They can also adjust the workflow as clauses are changed, adding or changing approvers automatically when the language or terms are edited by an employee or a third party. They also track all versions and approvals to provide an audit trail for the entire negotiation and approval process.
In addition to ensuring the contract is drafted correctly, a contract management software tool can create a centralised repository that allows documents related to the contract (compliance questionnaires, acknowledgement letters from the counterparty, annual certifications from contracting parties, due diligence reports, etc.) to be attached to the same record. This provides compliance pros a means to consolidate all critical information in one place.
Recent enforcement actions show that government regulators will not tolerate a ‘check the box’ mentality with respect to third-party due diligence and subsequent monitoring. Meanwhile, many customers, recognising the need to proactively manage risks in their supply chain, are increasing the scrutiny of supplier’s ability to meet obligations. As a result, it is critical that a company’s compliance program is ensuring that various obligations are being met either before entering a contract with a customer/supplier, during negotiations or post-execution.
For most enterprises, understanding contract obligations at scale and maintaining visibility into those obligations over an extended contract period can be near impossible, especially if it relies on human-driven systems. A recent case study shows how a single missed obligation can have an
A software development company had among the obligations included in its contracts a clause requiring that the clients’ data, proprietary information, and intellectual property (IP) be removed from the vendors’ computers on completion of the project.
This provision was meant to assure clients that their data and IP would not end up in the hands of any third party using the same vendor. Failure to fulfill this obligation would expose the company to expensive litigation and, worse, cause severe reputational damage.
Yet this obligation was overlooked in at least one instance. Twelve months after the conclusion of a project, the company received a notice of breach of contract for improper use of proprietary information, and the customer ultimately sued. The claim amount in the lawsuit crossed the materiality threshold, forcing the company to make a disclosure in its corporate filings with its regulator. This damaged its reputation with the public, and worse, it raised eyebrows with potential customers.
So, what went wrong here? Simply put, in this instance the contract and its obligations were not being tracked, and even the project manager was unaware that all data and code pertaining to the client on completion of the project needed to be deleted. Unaware of this obligation, some developers did not scrub the proprietary code developed for the project from their computers, putting the company at serious risk.
By utilising modern contract management software, companies can turn contracts from static documents into live documents which can interact with humans, surrounding systems and ultimately even other contracts to ensure obligations are fulfilled, thereby reducing risk. Compliance requirements can be addressed at every stage to meet the needs of every stakeholder. For example, for financial services companies, workflow rules built into the software can make Know Your Customer (KYC) requirements a pre-requisite of any contract approval process.
In addition, emerging artificial intelligence tools can aid with extracting post-execution obligations buried within contracts, allowing the system to actively alert contract managers to upcoming commitments to customers or flag any missed obligations by suppliers.
Increasingly, customers and regulators are holding companies accountable not just for their own actions but for those of their extended supply chain partners. Companies like Apple, Nike and others have suffered significant reputational damage from actions taken deep in their supplier networks.
Yet for organisations with complex, global supply chains, managing commitments and achieving complete visibility into those networks is no easy task. While a company may have visibility into the terms with Tier 1 suppliers, many do not have visibility into the obligations being passed down to ‘tier n’ suppliers. This lack of visibility results in an inability to spot risk and mitigate against failures can quickly cause reputational damage, particularly if it leads to failure to deliver on a promise to a customer.
One example of a company using contract management technology to ensure sustainability compliance across its supply chain is Daimler. As one of the world’s largest producers of premium
cars, the company works with more than 400,000 suppliers worldwide. With such a complex supply chain, the company needed a solution that could improve visibility into how ethical and sustainable sourcing terms were being propagated down its supplier network.
As part of the transformation of its contract lifecycle management and sourcing processes, the company has developed a joint blockchain initiative with Icertis that uses AI to automatically verify contractual obligations around agreed sustainability terms. The framework provides the reassurance that all parts, services and supplies are ethically sourced and companies throughout the supply chain are fully compliant with key legislation. Similarly, Daimler’s suppliers can prove that they comply without exposing other details of their subcontracts with the broader supply chain.
When starting a journey to digitize contracts, it can be difficult to know where to start. It may be tempting for businesses to adopt a piecemeal approach, applying contract management solutions to departments where the compliance process is particularly burdensome.
In its recent report on contract lifecycle management, Gartner observed that many organisations that have implemented a contract lifecycle solution have done so for just a portion of their business or a specific business function. This approach can be counterintuitive and, as Gartner identified, results in inefficient process workflows and deployment of multiple tools.
The first building block to any successful contract management strategy should be ensuring that contracts are digitized in one place and centrally managed.
A platform that spans all departments, divisions and geographies will give full visibility across every contract for every user, providing a complete view of dependencies, risks and obligations. Moreover, it will provide a strong clause, template library and rules engine, using approved language from contracts, easing contract creation and driving the right approval flow, while ensuring compliance.
So, the case for contract management is clear. Not only can managing contracts manually eat up valuable time and resources, it will allow inconsistency and risk to thrive. Whether that’s missed deadlines, obligations, compliance with legal standards or internal guidelines – all can significantly damage important supplier and customer relationships, even opening up a company to litigation.
As the pace of global business continues to accelerate, alongside an increasingly complex regulatory landscape, agile organisations should adopt a fast, reactive and nimble approach to trade, commerce and customer/supplier relationships. Digitizing contracts will ensure any organisation is equipped with the right tools to ensure compliance, improve business performance and brand reputation.