This article is my expression of advice to all businesses to take a meaningful look into the health of their existing contracts and business relationships. My other advice is for businesses not to take this exercise as a step towards transformation, but to understand that at this time, a contract health check is an affordable and doable means of their survival.
Three specific aspects of ‘contract audit’
First of all, this type of “legal audit” or ‘contract health check’ will indeed reveal where they truly stand in their existing contractual partnerships, business relationships.
It will take a detached snapshot of the monetization they can expect from existing contracts; if neither of the contracting parties does anything to improve or deteriorate the existing dynamic relationship, what type of monetization can be expected from the existing contract, as it is.
If you identify a particular situation, which you know is bound to become an issue later, proactively addressing it will better enable you to renegotiate contract terms or discuss mutual concessions or allowances.
Since we are all in the same boat right now, demonstrating this kind of insight and productive attitude towards your existing contractual duties will only strengthen your business relationships. The level of transparency and collaboration needed at the moment to preserve existing businesses in this market cannot come to exist without an up-close, case-by-case legal, technical and otherwise meaningful appraisal of those business relationships.
If contractual obligations cannot be met, it is essential to maintain open lines of communication.
The second and more action-oriented approach to contract auditing is to identify contract value leakages.
Briefly put, the notion maps the value of a contract at three specific points in a contract’s lifetime.
- The value captured during procurement “Value Promised.”
- The business case “Value Expected.”
- The value actually delivered by the contract “Value Realized.”
There is thoroughly documented evidence that the Value Realized reduces to 80% of the contract’s Value Promised.
About 12% of loss in value is attributed to hard leakages, i.e. such as invoicing errors, unrealized pricing or work scoping adjustments, and non-compliance with obligations. The remaining 8% loss is caused by the company’s inferior business management capabilities, for example, poor customer experience, losing renewal opportunities, and inability to retain clients.
Typically, the generally identified sources of leakages are identified to be a result of:
- Poor contract quality;
- the high cost of contracting; and
- inadequate contract management.
When I first started talking about contract value leakages two years ago, I took an “all in or no-win” position to how companies must plug the leakages. At that time, my motive was for businesses to capture sustainable long-term contract management benefits, both monetary and non-monetary.
But as I said in the beginning, I am not talking about spurring a transformation anymore. I am talking about embracing contract management for its use in a crisis management context. For present purposes, businesses do not need to venture into some ambitious overhaul of their contract management systems (as much as businesses clearly need it.)
For now, any business prompted to implement a contract performance management plan by its working capital needs or other immediate concerns will be wise to start by prioritizing those aspects of contract management that will reap benefits in the short-run.
Following a systematic contract performance review, businesses almost always are incited to make deliberate and planned collection efforts – because there will be collectables. Of course, it’s important to be creative in how you will actually go about making those recoveries. Proactive intervention and regular contact with contracting parties and business partners will be critical here.
In my view, a priority-based approach to embracing and implementing contract performance management should first target contract value leakages caused by inadequate contract management and focus only on correcting instances of hard-leakages.
This means that building a single contact repository, creating contract playbooks, standard terms, and templates would not be an immediate priority. Nor will the businesses attend to creating processes or building the culture, work ethics, and soft skills needed to tap the opportunities they lose from the soft leakages (poor customer experience, inability to retain clients etc.)
The third aspect of the contract audit will be related to the pandemic’s direct impact on a company’s legal exposure, risks, and liability. Addressing this element of the contract audit is where businesses may have to explore unique legal positions under the laws of frustration, force majeure and ‘mistake of contract’.
If the ‘contract audit identifies any such threat’, the particular situation will become a matter for early legal assessment, followed by a concrete strategy and action plan.
Starting parameters of the audit scope
For example, a shipping company can initiate a contract health check or legal audit by pulling out all of its:
- active charter parties for hire collections, payments or rate adjustments related issues.
- shipbuilding, sale and purchase agreements, loans and mortgage documents for upcoming financial commitments and related mutual obligations.
- Any joint ventures, alliances and investment agreements it may have with strategic partners for any renegotiations or actions needed to protect these ventures.
Similarly, contract performance review by other businesses such as construction companies, real estate developers, oil exploration and drilling companies will be of similar volume and limited to core types of transaction documents.
I think a contract audit of this scale would be a fantastic start to adopting the holistic and integrative contract management framework.