How to Ensure Contract Compliance
Contracts are important and can be an incredible source of value for organizations. They define the relationships that your organization has with its suppliers, customers, and other business partners. Significant time and effort are often invested in the process of drafting, negotiating, and reviewing contract terms.
This is all to make sure the contract accurately reflects the relationship the parties want to have.
However, contracts can also be a source of risk, inefficiency, and delay if they are not managed carefully. To get the most benefit out of contracts, you must embed contract compliance at every stage of the contracting process.
Contract compliance is the principle that the organization’s contracts – and contract processes – must comply with pre-defined standards and policies. These are all designed to maximize the value provided by each contract, whilst minimizing the risks.
In this article, we’ll walk through the lifecycle of a typical contract. This will show you how you can use contract compliance at every step to create more value for your organization.
There are some strategies that you can adopt that will help encourage contract compliance, before you even start to look at a specific contract.
Understand who “owns” contract compliance
If you are serious about embedding contract compliance across the organization, it’s important to know which business function will be responsible. A good place to start is to look at where contracting already takes place in the organization and identify those people who are already involved.
For many organizations, contracting is spread across teams such as Procurement (for vendor-facing contracts), Sales (for customer-facing), and the Legal Department. There may also be a Risk and Compliance team that might set minimum requirements that need to be reflected in contracts.
Look at what types of contracts the organization regularly enters into and whether it usually uses its form of contract or that of the other party. Common examples of contracts that are used regularly might include employment agreements, non-disclosure agreements (NDAs), or customer contracts.
Once you have undertaken this exercise, it should be much easier to apply the most suitable compliance processes for each contract type.
Develop a Process for Preparing New Contracts
Compliance should start from the point at which a new contract is requested – the “contract initiation” stage.
For contracts that are used repeatedly, the organization should have pre-defined templates. Templates will generally reflect a balance between the risk profile the organization is willing to adopt and the position that others in the market are willing to agree.
When using templates, make sure you consider the following questions:
- Who will use the template – will it be “self-serve”, or will the contract always be prepared by a particular department?
- Is the template and process sufficiently clear and easy to use so that it can be completed without there being any scope for errors?
- What is the process for varying the template terms? Which types of changes to the standard terms is the user permitted to make, and which need to be escalated for approval?
By having a template – and a robust process for how the template is to be used – your organization can dramatically reduce the variability between contracts. This will make it much easier to identify any non-compliant contracts.
Have a Similar Process for Reviewing New Contracts
A similar process should apply when you receive a contract from another organization that you need to review.
A useful tool here is a compliance review checklist. This sets out the company’s policy on:
- Certain minimum clauses or positions that the organization will always require to be put into its contracts. For example, a vendor might insist that it retains ownership of goods until it has been paid in full.
- Clauses that the organization will never accept. For example, the company might refuse to agree to an uncapped indemnity clause.
- Clauses that need to be escalated for approval. For example, a vendor’s payment clause might usually give its customers seven days to pay their invoice, but the vendor may agree to a longer period if signed off by the Chief Financial Officer.
You can then use this checklist to make sure any potential new contract complies with your organization’s standard position, and that any unusual or onerous risks are flagged for further consideration.
Who Can Approve and Sign Contracts?
Many organizations have in place a contract approval policy. This usually gives authority to managers at different levels of the organization to sign off on different types or sizes of contracts and usually imposes a monetary limit (above which the contract needs to be escalated).
The approval process might follow a pre-defined workflow. By the time the final version of the contract is ready to sign, this process will make it clear that it has been given, for example, budget approval and a full review by the legal team.
The approval policy and workflow are intended to work with the organization’s policy on who is permitted to sign documents. This policy will be partly determined by any applicable legal requirements. There is also a trade-off to be made here. Limiting the number of people who are authorized to sign contracts makes it easier to control and supervise the process, helping ensure contract compliance. However, this may result in an increased workload for those individuals. Getting a balance is important.
Consider How Contracts Are Stored and Accessed
Compliance becomes difficult to monitor when contracting is happening in different places and different business units, maybe with each following their process. To ensure contract compliance, you need visibility over what is happening across the organization.
A key goal for compliance is therefore to have a system that centralizes the storage and administration of your contracts. At a minimum, you should try to have a contract register – a full list of all contracts that the organization has entered into. Better still is to have a centralized repository in which copies of all contracts are stored.
Your contract storage can take the form of a physical room or vault where hard copies are kept, but a digital contract management system provides many more benefits, such as:
- Allowing you to access contracts quickly and from any location, so you can see what was agreed with the other party.
- Being able to control access to individual contracts, so that system users are limited to being able to view only those contracts relevant to their role.
- Using contract metadata to quickly prepare regular management reports or answer specific questions. For example, a question like “how many customers contracts over a particular value are due for renewal in the next month?” would be quick and easy to answer.
Performance and Administration of the Contract
It’s important to ensure contract compliance continues during the performance phase of a contract. Strategies to encourage compliance include:
- Contract reviews. This may involve a scheduled review of the vendor’s performance (for example, checking that the vendor is complying with KPIs). If the review is conducted in collaboration with the vendor, it might be an opportunity to identify areas where both parties’ performance can be improved.
- Using change control procedures. “Scope creep” can be a source of risk for the parties – where the scope of what the supplier is being asked to do changes during the term of the contract. To improve compliance, include a change control procedure in your contracts and make sure it is used so that any changes to the scope or pricing are properly documented.
- Managing key dates. Another major source of risk is missing key dates – for example, not exercising an option on time, or failing to renew the contract when it expires. Set up an alert system so that you get a reminder of key contract dates at the right time.
Undertake a Contract Compliance Audit
Audits are a valuable tool to check on how effectively contract compliance is being implemented across the organization. Audits might be scheduled on a regular schedule (for example, annually) or as a one-off to target a specific problem. They may be carried out by an internal audit team in large organizations, or sometimes by the engagement of an external auditor. In particular:
- Audits can be used to check the level of compliance with contracting policies across the organization. This can help confirm that the system is working – or identify any problem areas that might need further improvement.
- Audits can also be carried out on individual contracts, to check that the parties are complying with their respective obligations. Some contracts contain a specific audit clause that allows one party to inspect the records and files of the other party – for example, to verify that a vendor has accurately calculated the prices being charged.
Communications and Training
Many organizations invest significant time and effort in developing and implementing compliance processes, only to find later that their employees don’t know what to do or are bypassing the process to get their work done. To tackle this problem, any contract compliance program must include an effective training strategy.
Training can focus on, for example:
- Teaching or reminding staff about what policies and contract processes apply and why these are important.
- Where to find contract-related information, including details of contract approval and authorization limits.
- How to use the contract templates that are provided.
This training can be provided to new starters and as an annual refresher. Think about creative ways to make the training effective – so that employees don’t simply rush through to “get it done”. You might also want to consider implementing more in-depth training for targeted groups – maybe those that are in the field and using contracts on a more regular basis.
Similarly, it’s important to have in place an effective communications strategy. For example, consider whether it might be worthwhile communicating with staff if a compliance investigation or audit has identified issues, or a failure in contract compliance has resulted in the loss of business or litigation.