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The Argument For Standard Contracts

June 7, 2010

An IACCM member asked for help with gaining buy-in from his Legal department to the development of standard contract terms. While many organizations have had these in place for years, there are still a large proportion working to develop standards – or perhaps revising their initial approach.

This blog contains most of my response – I am hoping that others will add their thoughts and experiences, some of the ‘do’s and don’ts’ of standard contract templates. In this case, the focus was on Procurement, but I think most of the observations apply equally to sales contracts.

Standard templates improve business control, reduce risk and increase efficiency. They have been adopted by more than 70% of large companies. Specific benefits include:

–          Reduced operational costs (managing variations)

–          Reduced cycle times for contract review and approval

–          Scarce, highly skilled resources (such as Legal) able to focus on important issues and agreements

–          Change management simplified (because you know what is in the base agreements)

–          Business control increased (variations can be identified; new policies / procedures simplified)

Here are a few examples of recent incidents when having standards proved beneficial.

 –          When two major companies were recently hit by major reputational issues, the law department had to immediately deal with a range of damage limitation activities, some of which required detailed knowledge of the relevant contract terms. In the words of one General Counsel, “If I had not had standard contracts and confidence in how they could be handled, we would be out of business”

–          With today’s diligence procedures, it has become increasingly important for law departments to be able to confirm the nature of their contractual obligations and commitments. For example, M&A activity often demands insight to areas such as termination rights, assignment rights etc. Many GCs are concerned about lack of visibility in areas such as this – and the time delays that can be created by having to check every contract.

–          The volatility of today’s economy has made it critical for the law department to know what is in their contracts. Executive management expect them to know whether particular actions can or cannot be taken. For example, during the recession, many companies unilaterally changed payment terms, or sought to exercise termination rights. Without standard templates, this became a time-consuming – and risky – task.

–          This issue of volatility is resulting in top companies re-thinking many of their standard terms. For example, we have been in contact with several recently that want to outsource aspects of their contract management, but realize that their agreements may not allow this (due to confidentiality undertakings etc). They are having to check every contract before they can take action – and in many cases go back to individual suppliers to negotiate waivers or changes.

–          Law departments in many businesses are increasingly looking at ways to automate their contracts. They want reliable repositories; they want to be confident about the competitiveness of their terms; they want easy access to what has been negotiated; and they do not want to be seen as an inhibitor to getting business done. They also need to address workload issues. So at companies like Cisco, CSC, ArcelorMittal, LG Electronics, Verizon, Dell, Procter & Gamble etc etc, the law department is showing leadership or partnership with Procurement to ensure there are standards in place that reflect business needs and drive savings. In the words of Mark Chandler, GC at Cisco: “Legal must move from being a gatekeeper, to being a gateway”.

 So without standards, there is no platform from which to manage change. This is important, because many businesses (especially like yours, where there are multiple brands and profit centers) presume that ‘standards = inflexibility’. But this is actually the opposite of the truth. Standards are in fact a pre-requisite of flexibility. Unless you know the base-line, change cannot be managed effectively or rapidly. You cannot empower the businesses to make decisions.

Overall, ‘contracting excellence’ is driving a minimum 5 – 7% improvement to the bottom line. Standard terms are only one element of this – but they are a fundamental element and without them, other improvements simply can’t be made.

 However, be careful not to drive a ‘one size fits all’ approach. You must think through the types of relationship you wish to enable as a business as well as the categories to be covered. The structure as well as the content of contracts will be affected by this portfolio. For example, IBM, has 8 relationship types that it enables; and there are then variants depending on what is being bought – for example, software, services, products, ‘solutions’. The terms and conditions must be drafted to sit within each relevant contract template. Many times, the same term can apply to every agreement (for example, the Force Majeure clause); but others must be sensitive to the type of acquisition and the relationship (for example, IP rights).

Once you have templates, you can also develop a ‘playbook’ that offers guidance around the rules and procedures to follow when changes are to be made. The key point with standards is that if they are suited to the nature of the transaction or deal, they offer real efficiencies and enable the parties to focus on selectedd areas for negotiation.

5 Comments
  1. Tim,

    Completely agree on the advantages of standardizing contracts. However, standards really don’t solve the “knowing what’s in your contracts problem” highlighted in many of your examples. Although the actual numbers will vary by company, on average, 50% of contracts are going to be on someone else’s form, and of the contracts you are lucky or powerful enough to get on your standard form, many of those may be highly negotiated. So standardizing your contract templates, while important, doesn’t necessarily mean that you know what’s in your contracts or can find contractual information easily. This is especially true when you consider that most companies have a body of legacy contracts created with different, or no, standards.

    Companies need to consider both template standardization and getting control of the information in their signed contracts as part of their overall contracting strategy. Both are important in efforts to increase efficiencies, reduce risk, etc.

  2. Scott Hunger permalink

    David,

    I wholeheartedly agree with your comment to Andries. I would add that furthermore, it is very important that despite any development of “standard contract templates” which a company has choosen to invest time and money into, the significance of a “final contract review and analysis” cannot be overemphasized, despite the additional time and money it will cost the company because of the legal commitment which an authorized contractual signature represents.

    Scott Hunger, Esq.

  3. Chris Rawlings permalink

    I agree with both David’s and Scott’s comments. Standardisation of contracts is something which should be striven for, although in my experience, each deal invariably ends up with subtle differences, through the need to address both specific customer requirements and the different programme-related aspects (usually around risk) of each deal. This in turn means that every contract needs to be individually understood before any action can be taken. Automating contracts is therefore never going to be an option unless you are able to customise each new contract, or perhaps the balance of power is heavily in your favour (for example, car hire agreements). The value-add for Commercial managers is how well the contract is made to fit the situation, albeit a head start is welcome in terms of starting from a known baseline and only considering the required differences.

    • Chris, thanks for this comment.

      I want to ensure there is no misunderstanding of this article recommending standards. I too come from a background where ‘every deal is different’ – and indeed may often be based on the other side’s paper. Neither scenario invalidates the need for standards – nor for that matter the benefit of automation. Quoting from the blog: ‘without standards, there is no platform from which to manage change. This is important, because many businesses presume that ‘standards = inflexibility’. But this is actually the opposite of the truth. Standards are in fact a pre-requisite of flexibility. Unless you know the base-line, change cannot be managed effectively or rapidly. You cannot empower the businesses to make decisions”.

      As the blog highlights, the absence of this baseline carries many costs and risks. And to be honest, the extent of deal variability is often a result of this, not its cause.

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