Contract Analysis

What is Contract Analysis?

Contract analysis is the ongoing, real-time process of reviewing legal terms related to transactions and business relationships. It’s a vital process that focuses on the status of the contract, its clauses, and changes in organizational policies, with the option to compare current contracts against previous versions​​​​​​.

The core objectives of contract analysis revolve around:

• Understanding and managing contract risk
• Monitoring contract compliance
• Improving decision-making processes
• Identifying opportunities to be more efficient or customer-friendly

Contract analysis varies between organizations due to the intricate and technical nature of legal documents and their data. Advancements in legal tech have led to AI-driven contract management software, which automates and streamlines the contract analysis process.

Synonyms

• Contract review
• Contract abstraction
• Contract due diligence

Importance of Contract Analysis in Contract Lifecycle Management

“Contract lifecycle management” describes your company’s overarching process for creating, executing, and managing contracts for your leads and customers. The “analysis” portion of the contract management process is specifically responsible for analyzing your contracts and identifying areas of risk, opportunity, or non-compliance.

It’s important for:

• Extracting important data for decision-making purposes
• Improving outdated contract language
• Including and excluding particular contract terms and clauses
• Identifying potential risks, profit-draining errors, and conflicts
• Enhancing your contract management processes

Lawyers and contract managers can better understand company agreements by analyzing key clauses within them. They gain immediate and comprehensive insights into these valuable documents as well. And, by analyzing contacts, legal teams and contract managers can better identify inefficiencies in their contract process, as mentioned earlier.

Benefits of Contract Analysis

Risk Mitigation

You might not realize how much risk you’re taking on by leaving a contract as-is. For example:

• A lack of dispute resolution provisions could result in a long, expensive court battle.
• Outdated language could cause compliance issues or lead to financial losses.
• A conflict between two agreements would confuse stakeholders and harm future business relationships.
• Insufficient protection against liabilities or termination leaves you in a vulnerable position.

The same way you’d proofread an essay before submitting it, you always want to analyze contracts before putting pen to paper. The difference here, of course, is forgetting a section won’t get you a B instead of an A, it could cost you tens of thousands of dollars and countless hours of your time.

Cost Savings

On average, poor contract management practices (like failure to perform contract analysis) cost companies ~9% of their total revenue. If you don’t have a process for ongoing contract monitoring and you haven’t had to deal with a costly and complicated legal issue yet, you’re getting lucky.

The right contract analysis process help you pinpoint where errors, opportunities, and risks exist. This allows you to be proactive, rather than reactive, when you draft, redline, execute, and modify contracts.

Improved Compliance

If your contract language doesn’t reflect the current regulations and laws surrounding it, or your business relationship has had new developments since the contract’s creation, you’re at risk of violating its terms (as is the other party). You won’t have to worry about missing these critical changes if you consistently analyze all your business contracts.

This is especially important in heavily regulated industries like FinTech, healthcare, banking, and legal. Failure to comply with regulations can result in expensive penalties, negative press, and potential lawsuits.

Without proper revision or oversight, there may also be unspecific clauses that don’t provide effective guidance on things like service delivery or payment terms. On a business-customer level, the confusion that stems from this makes for an incredibly frustrating customer experience.

Enhanced Negotiation Strategies

An often-overlooked benefit of contract analysis is the actionable insights it provides for future contract negotiations. By understanding the specific language and terms that have caused issues in previous legal agreements, you can enter negotiations with a stronger stance.

For example, if you’ve noticed that certain clauses lead to disputes or delays in payment, you can use this information to push for changes during the negotiation process when a buyer suggests them. Additionally, by analyzing the success rates of various contract terms and clauses, you can choose terms that are more likely to be accepted while still being feasible for your business.

Identify Opportunities to Improve Contracts

Contract analysis forces businesses to think critically about their contracting process. As a result, they often find ways to make them more efficient and customer-friendly than before.

It also encourages them to carefully look at their clauses and terms, and how the impact sales performance, revenue, partnerships, compliance, and customer satisfaction. Over time, they can create optimal business contracts by using these insights.

Tools and Techniques for Contract Analysis

Manual Review

This is the old school way of analyzing a contract. It’s a hands-on approach where legal professionals or contract managers conduct a detailed review of each document.

They typically follow these basic steps:

1. Preparation. Before diving into the actual review, they dive into the parties involved, the purpose of the agreement, and areas of concern.
2. Reading and understanding. The reviewer meticulously reads through the entire contract to grasp its scope, terms, and conditions fully. This step requires a good understanding of legal terminology and concepts.
3. Identification of key elements. Depending on the goal of the analysis and the nature of the contract, the one analyzing it will pay attention to different elements. For example, if they’re looking for potential risks, they’ll focus on liability clauses and compliance issues.
4. Risk and compliance assessment. The reviewer evaluates the contract for risks like unclear obligations, penalties, or unrealistic deadlines. They also verify compliance with laws, regulations, and industry standards.
5. Comparison with standard templates. If available, they compare the contract to standard templates or previous contracts to ensure consistency and alignment with organizational policies.
6. Annotation and redlining. The reviewer annotates or redlines problematic clauses and terms requiring modification, clarification, or negotiation.
7. Summarization and reporting. A summary of the findings, including any potential risks, non-compliance issues, and suggested amendments, is prepared for discussion with stakeholders or negotiation with the other party.
8. Follow-up. Based on the review, the contract may undergo revisions and further negotiations until all parties reach a satisfactory agreement.

This method is time-consuming and frequently results in human error. It also isn’t scalable, which makes it increasingly difficult to manage as the number of legal documents your business handles increases.

Automated Software Solutions

Analyzing contracts by hand is less than practical, which is where contract AI comes in. With artificial intelligence, machine learning, and natural language processing (NLP) capabilities, contract management software can help you:

• Pull important data and clauses from contracts in seconds
• Compare contracts to identify inconsistencies and discrepancies
• Highlight potential risks and non-compliance issues
• Provide insights and suggestions for improvement
• Generate analytical reports on contract performance and trends

Within contracting software, you can also annotate and redline contracts, create clause libraries and standard templates, save every agreement in a contract repository, and track changes made throughout the negotiation process. And with contract version control, you can easily compare and review past versions of the contract.

Data Extraction and Analysis Tools

In addition to standard contract management capabilities, most contract platforms will have an add-on or built-in feature for data extraction and analytics.

There are a few technologies working here:

• OCR (optical character recognition) transforms scanned documents into machine-readable text.
• NLP uses machine learning algorithms to read and understand contract language.
• Machine learning identifies patterns, maps clauses, and extracts data.
• Custom reports are presented depending on what you’re analyzing the contract for.

The output is presented in charts, tables, spreadsheets, and interactive graphs to help you visualize and understand the contract data better.

Contract Analysis Steps

Identification of Key Terms and Provisions

In this initial stage, you start with a document you want to analyze. You’ll sort through the contract to identify the important details in a process known as contract abstraction.

• Payment dates and terms
• Performance obligations
• Delivery timelines
• The termination clause
• Indemnification and liability
• Confidentiality agreements
• Regulatory compliance
• Contract renewal dates

These are just a few examples, as the specific terms you focus on will depend on your goals for the contract analysis.

Examination of Legal and Business Risks

From there, you’ll need to evaluate the risks associated with each provision.

• Does this clause expose us to potential legal liability?
• Are we taking on too much financial risk?
• Could this section violate regulatory requirements?

By identifying and assessing the risks, you can develop a plan to mitigate or eliminate them.

Assessment of Compliance Requirements

Many contracts are subject to various laws, regulations, and industry standards. As part of your analysis, it’s essential to ensure the document complies with these requirements.

• Are there provisions that violate anti-trust or anti-bribery laws?
• Is the contract in line with industry-specific regulations?
• Does it include clauses for data protection and privacy compliance?

Not only is compliance important for legal reasons, but it can also protect your reputation and avoid potential fines or penalties.

Comparison to Standard Templates

By comparing the contract to standard templates or previous agreements, you can identify any discrepancies or deviations. This step ensures consistency and alignment with organizational policies.

• Are there clauses that are significantly different from our standard template?
• Have we negotiated similar terms in previous contracts?
• Are there any provisions that may create inconsistencies or confusion when compared to other agreements?

Evaluation of Performance Metrics

Finally, you can use your contract management software to analyze the performance of past contracts and identify trends.

• How long did previous negotiations take?
• Did we experience any delays or disputes during implementation?
• Have there been any compliance or risk management issues?
• If so, how many and what was their cost?
• Have we brought down disputes and noncompliance instances over time?

By analyzing this data, you can improve your contracting process and make more informed decisions for future contracts.

Challenges in Contract Analysis

Volume of Contracts

Perhaps the most significant challenge with contract analysis is the ever-increasing volume of contracts you’ll be working with as you grow your business. Finding a few terms in one several-page contract among thousands of customers, partners, and vendors is like finding a needle and a haystack. And it creates more problems than just that.

The first challenge is ensuring you have the right human and technological resources to handle the increasing volume of contracts. Contract managers, lawyers, and sales executives can only handle so many documents at a time.

Complexity of Language

The language in contracts must accurately reflect the current state of your company and comply with existing laws and regulations. Inaccuracies and outdated clauses can expose your business to risks and legal challenges.

Beyond that, it’s difficult to read through pages and pages of legal jargon. As a result, the interpretation of certain clauses and terms may vary between parties, leading to disputes.

Inconsistencies and Ambiguities

In theory, every important term and condition in your agreement should be clear, concise, and specific. In reality, contracts often contain inconsistencies and ambiguities that can lead to confusion or disputes during implementation.

• Multiple terms used for the same concept
• Contradictory clauses
• Vague language that parties might interpret differently

Even as you analyze a contract, bias could cause you to miss something like this. For example, if an objectively unclear contract element makes complete sense to you because you helped create it, you might look past it despite its potential for creating problems on the partner’s or customer’s end.

Data Integration

According to Gartner research, poor data quality costs businesses an average of $12.9 million each year. The typical company has more than 2,000 data silos, among the most costly of which are data silos that occur between departments involved in contracting.

Without quality data, you can’t accurately audit your contracts for potentially costly compliance risks. That’s why, when choosing contracting software, your #1 priority should be seamless integration with your other business tools.

Best Practices in Contract Analysis

Establishing Standard Procedures

First and foremost, having contracting procedures everyone on your team adheres to speeds up the analysis process while reducing the risk of human error and bias. Consider making standard contract templates and setting specific control measures, like quality assurance checks.

Utilizing Technology Solutions

In 2024, do not attempt contract analysis without software. Today’s legal agreements are too intricate to handle manually. It would cost you way too much to do everything manually, anyway.

In addition to configure, price, quote (CPQ) and contract lifecycle management software (CLM), you should look into contract analysis software. It’s purpose-built to help you identify and classify all your contracts, create abstracts, analyze risks, opportunities, and compliance issues, and visualize your contract data.

Training and Skill Development

Not every member of your team is a contract expert. Still, everyone involved in the contracting process should be aware of how their actions impact the contract’s outcome. It’s a good idea to train the relevant team members on legal terms and clauses that are critical to your business agreements.

Future Trends in Contract Analysis

Artificial Intelligence and Machine Learning

AI systems are trained on vast contract databases to identify potential risks and unfavorable terms before they become problematic. Their predictive abilities help companies make informed decisions and mitigate risks in advance.

The same technology enables them to perform automated risk assessments. Combining AI with machine learning eliminates human error and bias in this critical step of the contract analysis process.

Moreover, by analyzing past negotiations and outcomes, AI can offer insights into effective negotiating strategies, suggest alternative clauses, and even predict the other party’s reactions. This can lead to faster resolutions and more favorable terms, ultimately improving the efficiency and effectiveness of contract negotiations​​.

Blockchain Technology

Smart contracts are code containers that replicate real-world contract terms in the digital realm. They automate contract execution when predefined conditions are met, which eliminates intermediaries like lawyers and reduces the risk of fraud.

Here, automation leads to reduced transaction risks and lower administration and service costs. Since smart contracts execute exactly as written and agreed upon, they also improve business process efficiency and reduce compliance risks over the long term.

However, smart contracts are not without their challenges. The so-called “oracle problem” highlights the difficulty in integrating off-chain events with on-chain smart contracts. Smart contracts rely on blockchain information, posing a challenge in triggering actions for events outside the network.

Additionally, blockchain’s public and immutable nature raises concerns about data privacy and compliance with regulations like the “right to be forgotten”​​.

Integration with Enterprise Systems

Companies are moving towards designing systems that treat contracts as digital objects, enabling obligations to be tracked and actions to be automated more efficiently. This integration aims to provide businesses with instant responses to critical questions directly from their contracts, thereby enhancing decision-making and operational efficiency​​.

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