What is Contract Governance?
What is Contract Governance? It refers to an organization’s reporting line to ensure all of its regular business practices are aligned. The standard for which those practices are aligned influences how contract governance operates within an organization. Some businesses have much stricter standards when compared to other businesses – They are regulated by internal supportive departments specific to their own internal guidelines.
Contract governance should not be construed with contract management, both are very different. Contract governance is the nuts and bolts of contract management and signifies the ethical and accountable design, management, and operations of the whole organization. Contract governance is the internal approach on how a company manages, controls and reduces the threat of supply disruptions while ensuring long term business goals.
Contract governance should be professionally designed and effectively executed to ensure risk management and control of costs for both products and services. In effect , contract governance is reserved for monitoring conformance to an established contract standard. Contract governance is essential because it demonstrates the ability of a business to meet any contract requirements to satisfy the customer.
When it comes to compliance, there should be an expected governance capability by an organization to be able to validate it is adhering to specific contract requirements. Put differently, contract governance involves being able to determine an organization’s ability to ensure that the contract implements and executes to its obligations. This means that: (i) the organization is checking compliance rules against known conditions for each product/service the organization sells and; (ii) is counting ‘violation occurrences’ over a determined period of time.
Typically specific areas that are included in contract governance involve: assurance of service quality; supplier and product performance; customer satisfaction and compliance; risk factors analysis and; research and development programs and compliance.
Essential Elements of Contract Governance
Effective contract governance requires a robust framework made up of several key components, without which no contract governance program will succeed. Those components include clear policies and procedures, defined roles and the delineation of responsibility, required tools and resources, and ongoing training.
Policies and Procedures
Contract governance begins with well-defined policies and procedures for managing the lifecycle of a contract. Contracting parties may have policies concerning contract approval, contract review, updates and renewals, the approval of changes, and signatories. Policies should be implemented through procedures that include checklists, templates and other tools designed to support the people who actually do the work. Procedures should also include assignment of responsibility and consequences of non-compliance.
Roles and Responsibilities
Roles and responsibilities for the key players in governing a contract must also be clearly defined. Some roles are obvious such as designate decision makers, approvers and reviewers. But others might not be as clear-cut. For example, is your legal department primarily a service provider that does contract reviews or a risk management function? Are your business representatives really contract owners or simply business liaisons with the vendor? Do you have a contract steward who ensures the contract is being properly managed? These roles are best codified as part of agency policies and procedures so there are no surprises or misunderstandings.
Tools and Resources
Once policies and procedures and roles and responsibility have been established, tools and resources to support the contracting parties should also be identified. Necessary tools can include checklists for reviewing contracts, self-audit review forms, templates for managing tasks associated with contract administration, and repository databases.
Training
Policies, procedures and tools are important components of an effective contract governance program, but so is ongoing training. Contract governance is required at every stage in the contract lifecycle and each stage involves many common tasks that may change from contract-to-contract such as contract negotiation, administration and performance. Therefore, training must be infusing in all aspects of the contract lifecycle and updated frequently.
Why Contract Governance Matters
Contract governance is paramount for organizations by ensuring that they not only define their own and counterparty’s rights and obligations, it should also ensure that the organization can effectively manage its contract assets through active and responsive administration and compliance monitoring, and efficiently deploy the contract’s assets through optimization of performance, reward delivery, rights and remedies, shortening of life cycle, etc.
Organization’s ability to leverage on and maximize their investments in key contracts and assets will ultimately lead to overall enhanced organizational performance.
Contracts are so important to an organization that its viability or survival could hinge on the absence or presence of well-managed and governed contracts. Sophisticated organizations have been able to gain some competitive advantages by understanding and managing their contracts in ways that routinely offset even some of the most competitive environments and factors in the industry (price, product development, innovation, service delivery, etc.).
Contract Governance vs. Contract Management
Contract governance and contract management are not the same thing, they are related but certainly different. Contract management is typically understood in a project context. That is, it’s part of the project lifecycle, from beginning to end. Contract management ensures pricing, terms and conditions are adhered to, including obligations under contract. Compliance with policies and approval processes within the organisation. Tracking of timelines, milestones, deliverables and reporting ‘up’. Contract governance tends to be seen as a higher-level view that instigates best practices. Bonds the obligations and entitlements with the controlling organisation’s goal and objectives. It may involve many stakeholders (including research, risk, finance, internal audit, internal control, legal, procurement, operational custodians, analysts, etc.). The ability to manage contractual relationships is foundational to business relationships. This includes the creation, management, and execution of a contract-usually involving a lot of people. A great example of this would be an ‘agreement’ such as a ‘head agreement’ or ‘memorandum of understanding’, which is an agreement that establishes the relationship of all parties, and it includes and is accompanied by various proposals, work orders, statement of works, change orders and so on. These documents all relate to the head agreement and act as updates or iterations, but it’s the original head agreement that sets the foundation. A single contract for a project that is supported by subsequent ‘agreements’ or ‘addendums’ is a good example of contract governance. When we talk about contract governance we’re usually referring to the systems and structures that should be in place. The need for layers of visibility, accessibility, control and collaboration over time frames, milestones, processes, users, compliance, obligations and entitlements. A lot of this is done in conjunction with policies that exist within an organisation’s structure. Contract governance provides the power to leverage technology that includes contract analytics, reporting, aids collaboration, integrates with financial systems and/or has the ability to manage the complexity of contract obligations coupled with a centralised view. Contract management relies on the access to past and current contracts and agreement to manage the deliverables and project. Contract governance provides the contextual and strategic advantages that pave the way for process automation and workflow. Contract management is the execution, Contract governance is the planning, facilitation, structure and arrangement of the contract. For contract governance to be effective, it needs to be aligned with the process and system design of contract management.
Best Practices for Contract Governance
The best practices in governance are built on a solid foundation of transparency and accountability. Such practices create an environment where employees and other stakeholders understand their responsibilities, are aware of the decision making criteria in place, and are able to identify the key players.
Regular Audits: Regular audits of contractual compliance are one way of ensuring that everyone understands their obligations and that those obligations match the agreements reached. An audit that assesses compliance with contractual obligations creates more transparency in decision making and places decision making processes under scrutiny. Additionally, a regularly updated database of agreements, their terms, and relevant information will enhance contract visibility and support contract management. The ability to readily access current versions of agreements will enable stakeholders, including those tasked with the performance of obligations under the contracts, to monitor compliance without ongoing input from legal staff. The increased availability of agreements will also allow the company to better assess its contractual relationships, and the effects of governance and contracting decisions made elsewhere in the business.
Technology: The use of technology to improve governance is now commonplace in both the private and public sectors . It has been reported that as at December 2016, around 20% of Fortune 500 companies were using artificial intelligence to some extent for legal purposes, including contract management. Not using technology means that you are likely to be missing out on opportunities to streamline workflow, improve accuracy, mitigate risks and save money. The importance of adopting new technologies to keep pace with competitors, and in some cases, many clients, will continue to grow. For those not confident in implementation of Artificial Intelligence ("AI"), there are many other ways technology can be used to improve contract governance. AI can be effectively used to conduct standardised legal reviews of agreements, provide alerts for key dates and obligations, and conduct automated approval processes to ensure that proper authority is exercised in decision making.
Continuous improvement: Contract governance will require continuous improvement. Continuous improvement requires a commitment to measuring progress against a set of goals, for example, an agreed % of compliance with obligations, % of contracts > 10MB, % of contracts reviewed in less than 2 weeks, costs associated with performance etc. Stakeholders should be consulted to get buy in and allowing the planning of implementation of appropriate measures to reduce costs and delays.
Implementation Challenges of Contract Governance
While organizations recognize the importance of having effective systems in place to manage contracts, there is a growing realization that doing so poses a steady stream of challenges. For many, these challenges are perceived as insurmountable while a good number of organizations make an attempt at adopting governance practices only to pull back and avoid them altogether. The most common of these include:
1. Inadequate resources
The key challenge to the breakdown of contract governance in an organization is often inadequate resources. This is usually manifested by a shortage in budgetary allocations for the implementation of contract governance policies and practices. Additionally, recruitment and retaining of adequate contract management resources is a significant issue for most organizations. In many cases, the finance department within an organization and especially the directors of finance may not understand the value proposition of contract governance and may be resistant to approving the allocation of budget to support its implementation. Inversely, many contract management departments found in legal, procurement, or risk management may not have a budget supportive of their functions and may be unable to apply themselves adequately to providing oversight to contract governance.
2. Resistance to change
As mentioned earlier, many organizations make an attempt to adopt contract governance practice only to pull back and avoid it altogether. This can sometimes be traced to how quickly the contract governance is adopted into the organizational culture. Once contract governance becomes more than an initiative and is transferred into policies and processes, it becomes integrated into the management of an organization and becomes more difficult to ignore or avoid. However, this growth may encounter resistance as it may result in the minimally acceptable effort towards contract governance becoming too great a burden on business units tasked with responsibility.
3. Oversimplified contract complexity
Complexities arise from poor contractual practices. It is important to note that the complexity of any given contract has little to do with the level of value it carries with an organization. As a matter of fact, every contract deserves the due diligence necessary to ensure the organization is not significantly disadvantaged by offering valuable resources in exchange for services or goods. The reward of ensuring that contracts of high-value are negotiated and implemented adequately cannot be overstated. To impose a one size fit all approach to contract complexity limits the value that could be received by the organization. Organizations often find that their risks of non-compliance or financial loss relating to the mismanagement of contracts are far greater.
The Evolution of Contract Governance
As businesses continue to recognize the importance of effective contract governance, new trends and technologies are set to shape its future. One major force driving change is the emergence of Artificial Intelligence (AI), which has the potential to transform every stage of the contract lifecycle. AI algorithms can analyze contract data and categorically apply legal rules, which can streamline processes such as contract review, negotiation, and renewal.
Beyond AI, smart contracts – self-executing contracts with the terms of the agreement directly written into code – are also gaining ground. As blockchain technology becomes more mainstream, these digital contracts may revolutionize the farmer – consumer relationship, ensuring greater compliance with agreed terms via automated transactions that are impossible to reverse.
Moreover, data analytics will increasingly impact contract governance. By analyzing historical performance data, organizations can renegotiate contracts, improve supplier performance, and reduce costs . Analytics can also help identify and manage risks associated with various contracts, facilitating a data-driven approach that enhances overall decision-making.
The growing move towards cloud-based solutions will enable easier access to and integration of contract information. In turn, this will facilitate collaboration and visibility across different departments and groups, creating a unified contract management strategy that is more adaptable to changes in the regulatory and compliance landscape.
Ultimately, the future of contract governance will depend not just on technological developments, but on how well organizations adapt their internal processes and culture to take advantage of the benefits these innovations have to offer. This will involve not only the integration of advanced technology, but also the need for ongoing recruitment and training to ensure that the necessary skills and expertise in contract management are available to capitalize on future trends.