Contract Management - Best Practices | Try Freshservice ITSM Tool

What Is a Contract?

A contract is a legally enforceable agreement between people or organizations for the purchase of products and/or services or a common project, goal, etc. Each person or organization who agrees to a contract is known as a “party.” The contract can be thought of as an understanding or a deal, where one party (the supplier) agrees to provide goods or services to the other party (the customer). A contract records the obligations, terms and conditions by which each party agrees to abide and what each party has agreed to do. This helps to avoid future misunderstandings. A contract protects the rights and needs of both parties and can drive them to be responsible for what has been promised. Contracts can be written or verbal, although it is difficult to prove agreements in a verbal contract. Contracts can be defined in a single document, in a collection of linked documents or as a separate section in an order a customer has placed with a supplier.

What Is Contract Management?

Contract management is the set of processes and techniques used to manage the end-to-end lifecycle of contracts. Each party to a contract should perform contract management, assigning responsibilities for it to individuals. The level of activity when managing different contracts can vary substantially. A contract for a customer to buy off-the-shelf products from a supplier will require little if any continuous involvement from the customer’s contract-management function, as the management actions under the terms of this type of contract would only be necessary if the supplier failed to deliver the products on time and of the specified quality. More complex contracts for products, such as high-value bespoke software developments or outsourced IT services, are likely to require the entire range of contract-management activities. This is because the customer is more likely to require specific terms and conditions in the contract with the supplier to manage the risks to the customer’s business.

What Drives the Size and Complexity of Contracts and Their Management?

Contracts have a wide range of sizes, contents and complexity, requiring different levels of management. Contracts will differ according to factors including:

The types of goods or services to be provided according to the contract – Different types may have different management requirements. Bespoke items often require specific contractual terms and conditions.
Intellectual property considerations – Suppliers want to protect their investments with specific contractual clauses.
The delivery of the goods or services – Managing phased delivery requires more complex contracts.
The length of time of the contract (the “term”) – Contracts that have a longer-term require regular review.
The total value of the contract – High-value contracts have terms and conditions to limit the customer’s risks.
The level of trust in the supplier – The customer may want specific requirements in the contract to manage the supplier.
Any compliance requirements placed on the customer from higher authorities – Some terms and conditions may need to be passed onto the supplier using the contract.

What Are the Typical Types of Contracts Used in IT?

Contracts used in IT typically are of several types, each of which has different characteristics, responsibilities and approaches for contract management:

Sales contract

This type of contract is between a supplier of standard “off-the-shelf” IT products or services and a customer. The supplier takes the lead role in contract management, defining the terms and conditions of the contract. Typically, the contract details will be the same for all customers. The customer accepts the contract’s terms and conditions by placing an order for the products/services, including a requirement to pay the supplier for them. In this type of contract, the customer’s contract-management activities are limited to determining if the goods/services were delivered and based on any terms for non-delivery defined in the supplier’s contract. The supplier’s contract-management activities are limited to defining the contract, communicating its contents during the ordering process and requesting payment according to the contractual terms and conditions. No negotiation occurs with the customer. Examples of where this type of contract and management approach applies include when a customer procures “shrink-wrapped” software, PCs, network services, cloud-based software services and desktop support services.

Purchasing contract

This type of contract is typically used when the customer wants to purchase bespoke products or services, or when it wants a higher level of contract management than is defined in a supplier’s sales contract. In this type of contract, the details will be specific to the customer and supplier. The customer will take the lead in contract management, including defining and negotiating the contract. The contract may be based on the supplier’s standard contract or the customer may have a contract template that matches with how it wishes to manage the contract. The customer will manage compliance of the supplier against their contractual requirements, taking remedial action as required and managing any changes to the contract. The supplier is also involved with contract definition and negotiation to ensure it can deliver according to the requirements of the contract. This type of contract includes the agreed approach to manage continuous delivery and compliance, and both parties normally sign it to signify their agreement. Examples of where this type of contract and management approach are used include the outsourcing of IT services, bespoke software developments and employment contracts.

Partnership agreement

This is a type of contract that formally documents the terms and conditions of a partnership of two different organizations, so they become “partners” in a commercial arrangement. In a partnership agreement, both parties will jointly manage the contract, acting as if they were a single organization. The contract may still contain individual liabilities for each party, but will also specify all joint liabilities. Examples of where this type of contract and management approach is used include a customer and supplier working together to develop a new product, which is then jointly owned; two suppliers working together to deliver services to the same customer; and one supplier providing hosting services and another providing application services. In this last example, each supplier would still have separate contracts with the customer, and the contracts would be managed independently.

Collaboration agreement

A collaboration agreement is used where several suppliers provide services to the same customer and where the customer has a contract-management requirement for them to work together. As well as individual contracts the customer manages, each supplier and the customer also have a contractual obligation to sign a common collaboration agreement. This type of agreement contains contractual obligations that are specifically designed to encourage all parties to work together, often including requirements for shared objectives, measuring the willingness to work together and collectively driving improvements. The customer or its appointed service integrator manages compliance of the contractual requirements. This type of contract and management approach is typically used where the IT supply landscape includes a need for service integration and management.

Sub-contract

This is a type of contract used between a supplier and another supplier, where the primary supplier has a contract with the customer to provide products/services but requires assistance from another supplier – the subcontractor. The primary supplier, sometimes called the “prime”, creates and then manages a contract with the subcontractor. The subcontractor has no contractual relationship with the customer, and it does not manage the subcontractor. The prime supplier is still accountable for delivering of its contractual obligations to the customer, even for any parts the subcontractor delivers.

Master-services agreement

A master-services agreement (MSA) is often used in contract management for complex purchasing contracts when a single supplier provides one customer with many different services. Common obligations of the different contracts are added to a master services agreement to reduce the size of each contract and simplify the management of these shared contractual obligations. Examples of obligations are payment terms, intellectual property ownership and approaches for contractual dispute management and resolution. MSAs can also be used with multiple suppliers providing services for a service integration and management landscape, where they have common contractual management obligations.

What Are Contract Management Activities?

Contract management includes several different activities and sub-processes. Not all of these are required for managing every contract. The activities include:

Defining the contents of a contract

Every contract should be carefully defined. Templates can be used to assist in defining contracts to support their management. The contract requirements will drive parties’ behaviors and the supplier and customer’s costs, and will also require management activities. Both parties must understand the implications of every element in a contract before it is signed.

Negotiating the terms and conditions of a contract

Some types of contracts will require negotiations between the customer and the supplier. This activity in contract management contributes to a successful contractual outcome, as negotiations help to ensure both parties are aware of and can fulfil their contractual responsibilities.

Agreeing on a contract between parties

The agreement can be formalized by signature (which can be electronic) and by confirming acceptance of terms and conditions while ordering goods or services or implied by conduct, which suggests there is agreement.

Communicating a contract’s contents

It is important in contract management to ensure the parties involved in the delivery and receipt of goods or services are aware of their agreed-upon obligations in the contract.

Ensuring compliance of contract terms and conditions

There is a risk that either party to a contract could fail to fulfil some of the requirements, either due to error or as a conscious attempt to save money. Hence, it is good practice in contract management for routine monitoring and reviewing of compliance according to the contractual requirements.

Taking remedial action if the contract’s terms and conditions aren’t fulfilled

If a check of contract-management compliance reveals an unfulfilled requirement, it should be investigated and resolved. This may require managing a change to the contract if, for example, ambiguous contractual requirements was the cause of the disagreement.

Managing any changes to a contract

Contracts are formal, legal agreements, hence, any changes to them must be managed, including negotiations and ensuring both parties agree to the changes.

Terminating a contract

Contacts are eventually terminated because they have reached the end of their term, one of the parties has breached a major contractual obligation or one of the parties ceases trading. Contract terminations should be managed, with the management approach and conditions for termination included in the contract. The contract should also include any obligations that continue after the contract termination has been managed to completion, for example, any persisting requirements for non-disclosure of sensitive information.

Why Is Contract Management Important to Your Business?

Contract management can benefit any business. From the customer perspective, contract management ensures the customer receives the goods and/or services being purchased. From the supplier perspective, contract management ensures it is only required to fulfill the contractual obligations for the money or other considerations it receives. Many customers contract with suppliers for a variety of goods and services, often using contracts with the supplier’s defined terms and conditions or using contracts external procurement consultants have defined who the customer has engaged, but without establishing contract management for those contracts. It is not uncommon for suppliers to fail to fulfill all of the obligations defined in the initial contract. What often happens is customers then fill the gaps without realizing they are incurring costs that are the responsibility of the supplier. Many long-term contracts include management obligations to review costs and refresh technologies. Without customers actively managing contracts, these reviews don’t occur. Effective contract management can provide these benefits for the customer and the supplier:

The customer is happy with the delivery from the supplier.
The customer realizes the expected business benefits.
The customer understands its obligations according to the contract.
The customer receives value when its customers purchase the provided goods and services.
The supplier is happy with the revenue and profit it makes from providing the goods and services to the customer.
The supplier retains the customer’s business.
The supplier cooperates with the customer and is responsive to change.
The supplier understands its obligations under the contract.
There are no unforeseen gaps in responsibilities.
There are no overlaps in activities.
There are no disputes about each party’s obligations and responsibilities.
There are no surprises.
If there are any required changes or issues, then a professional and objective discussion can be conducted.

What Are the Contents of a Best-Practice Contract?

A best-practice contract should be easy to follow, comprehensive, concise, understandable and legally enforceable in the country of use. Fulfilling these requirements will facilitate management of the contract and encouraging those involved in the delivery and use to abide by their contractual obligations. Contracts are formatted to assist these requirements. The contract is separated into titled sections to assist management, each focusing on a particular set of requirements. A section can also be known as an “annex” or a “schedule.” Each requirement in a section is known as a “clause.” It is usual to number each section and each clause. For example, section 1 would have clauses numbered 1.1, 1.2, 1.3, etc. This technique helps to reference particular requirements when designing, negotiating and managing the contract.

There are many templates available for contracts. These contract templates are usually customized to assist contract management for specific countries, industry sectors, types of services and size of services. Organizations can use these templates as the bases for their contracts, applying amendments suitable for their precise use. A list of typical contents is provided below. Items in bold are the minimum required for any contract.

Section	Description
Document title and reference	The name of the contract and a unique reference number for it
Parties to the document	Who is entering into a contract
Description/purpose	Description/purpose
Products/services	The products and/or services provided according to the terms and conditions of the contract
Version history	A contract is a controlled document that requires versions
Definitions	Defines all terms in the contract
Pricing	Any charges for the service and any variations in charging
Responsibilities of each party	Specific obligations of each party
Payment terms	How payments specified in the contact should be managed
Delivery terms	How the products/services will be delivered and how any losses will be managed
Warranty	Any warranty period during which issues with the products/services will be fixed free of charge
Contract assignment	Any restrictions that disallow the supplier or the customer to pass the contract to another party
Contract dates and term	The start and end dates of the contract
Default and remedies	How to manage any failure to fulfil the obligations, terms and conditions defined in the contract
Dispute and arbitration process	How to manage any disputes about the contents or meanings of the contents of the contract
Compliance with laws	Specifies which country’s laws apply to manage any contractual defaults
Confidentiality and non- disclosure	Any requirements for keeping the contents of the contract and the provided products/services confidential
Intellectual property rights	Who owns the intellectual property for the products/services provided according to the contract
Force majeure	Specific conditions under which both parties are freed of their obligations, such as during times of war, strikes or riots
Termination and exit	Rights and responsibilities of both parties for terminating the contract, including termination before the end of the contract term
Contract renewal	How a contract renewal will be managed
Authorized signatories and witnesses	Signatures of each party agreeing to the contract

How Should IT Services Be Described in a Contract?

A contract with a supplier to provide managed IT services to specific service levels will often include detailed schedules to define the service requirements. The service schedules typically include:

Security standards, including any necessary certification, such as ISO/IEC 27001
Service-management standards, including any necessary certification, such as ISO/IEC 20000
Technical requirements for interfacing services
Requirements for interfacing ITSM processes
Security requirements
Service-desk requirements
Performance-reporting requirements
Service levels
Key performance indicators
Service-review requirements

Contract Management Techniques

How Should Contract Management Address Compliance?

Following the award of a contract, contract management should periodically check both the supplier and the customer are complying with the contractual requirements, terms and conditions. Contract compliance checks should not wait until issues are identified, as the parties may not become aware of these until after the contract has been awarded. It is particularly critical for contract management to check compliance of financial details of the contract, including payments, revenue and incurred costs, as these can directly affect margins. A contract-management-compliance audit should start with a review to identify the areas of highest risk to the organization. There is a risk that overzealous compliance audits can damage the customer-supplier relationship. Contract management, therefore, should use a compliance approach to identify improvement opportunities to benefit both parties, and should not try to apportion blame. A useful compliance approach in contract management is to create a governance structure in which both parties have a vested interest in managing what are often highly complex contractual arrangements in a more collaborative, aligned, flexible and credible manner. The governance structure for contract management should define how the parties work together to make both day-to-day operational and strategic decisions. The structure should include a process to track jointly the overall performance of the relationship and to review regularly exit planning as well as activities to check compliance of specific controls and regulations, including traditional contract-compliance audits.

Contract Management in IT

A typical IT department will use goods and services many different suppliers provide and according to the terms and conditions of several different types and forms of contract. Each of these will require different levels of contract-management activities, ranging from none to substantial. Even if an organization has a dedicated procurement function with responsibility for agreeing, signing and managing contracts, IT must still be aware of any of its contractual obligations.

“Off-the-shelf” consumable sales contracts

Sales contracts to buy “off-the-shelf” goods, such as memory sticks, effectively end once the goods have been delivered. There is no need to manage this type of contract; however, IT should check the details of the contract to ensure it has no continuous liabilities with the supplier.

“Off-the-shelf” software sales contracts

A sales contract for software can seem similar to a contract for buying consumables, but most software contracts include continuous requirements for IT, concerning license management and ownership of the application. The terms of this type of contract often state the supplier retains ownership of the application software, however, the customer has just purchased a license to use it. If IT isn’t aware of these contract requirements and manage their compliance, then the organization could face legal action.

Bespoke software development contracts

Any contract with a supplier to develop bespoke software should include clauses defining who owns the rights to the developed software. The contract might specify the supplier owns the software assets, even though the customer paid for the development or ownership passes to the customer once payment has been made. IT must understand the terms of ownership, especially if IT subsequently amends the software for its specific use or need. ITSM asset management must be clear about the ownership of the assets, so it is reflected in its asset management database. IT must also understand the supplier’s responsibility for support and maintenance, so IT can avoid pressuring a supplier unduly to resolve an issue for which it is not responsible according to the contract and to ensure the appropriate amount of effort is expended to manage the contract.

Service-based contracts

Contracts stipulating a supplier provides continuous services to IT require the highest level of contract management, including contracts for services, such as application support, hardware maintenance, wide-area network provision, outsourced fully-managed services and facilities management. The level of contract management will vary according to the criticality of the service provided to IT and the organization, the quality of the supplier and its services and the contract requirements.

What Are the Challenges of Contract Management?

The challenges of contract management are common to most organizations. By developing strong skills in contract management and applying a common sense and pragmatic approach to managing contracts, these challenges can be overcome.

Creating understandable contracts

Contract management relies on contracts that can be understood. Specific skills are required to draft contracts that are comprehensive, concise, unambiguous, understandable without legal training and legally enforceable.

Using different approaches to contract management

The approach and rigor used to manage each particular contract must account for many factors, including the type of contract, the total value, the criticality to the business, the type of goods or services provided and the performance requirements of the contract. This can also vary throughout long-term contracts, with reduced management requirements as trust builds.

Checking contract terms and conditions

It is easy to accept contracts without checking the terms, especially the “small print,” which can lead to subsequent surprises when managing the contract. Someone with appropriate knowledge and attention to detail should check contracts before they are signed.

Knowing when to apply the contract

If contract management always refers a supplier to the contractual terms whenever there is a mistake or failure of the requirements, then the relationship with the supplier will soon deteriorate. Knowing when to apply the remedies for non-compliance can be a difficult skill to learn. The “three-strikes” approach can be useful, issuing non-contractual warnings for the first two instances of a breach.

How Can You Use Software to Track Your Contracts?

Many organizations now use contract-management software instead of relying on the manual management of paper contracts. Contract-management software can provide contract visibility, monitoring and compliance to automate and streamline the contract management lifecycle. Contract-management software has become an essential tool to track the multiple activities associated with contract management and to automate contract administration, track compliance, manage risks, produce reports and trigger alerts when action is required. Contract-management-software systems provide a centralized database to store the definitive version of contracts, which can enable rapid, secure access to the contracts from multiple locations. This avoids having multiple copies of contracts in several locations and managing different contract versions, which can cause delays in the contract management process and create disputes. Functionality in contract management software includes the capability to store contract documents of different formats; record different document statuses; track changes to them; search documents for a particular criterion or clause; compare different versions of documents; send alerts to contract management staff based on key dates; and provide workflow management for new contracts, including review, approvals and digital signatures.

Best Practices for Creating a Contract-Management Process

Follow these stages to create a contact-management process:

Discovery

Gather information on all contracts, including the structure, content and requirements for both your organization and on the other parties. Use this information to populate your contract-management software. Ensure your contract-management staff has the required contract-management skills and knowledge about your business.

Analysis

Analyze all contracts to understand and document the different types and their criticality to your organization.

Design

Design your contract-management process using best-practice guidance to suit your organization’s different types of contract.

Implement

Start to use the contract-management process for all new contracts, and all with a high criticality to your organization. Brief existing parties in advance to obtain their buy-in to your new management approach.

Improve

Conduct routine reviews of the effectiveness of your contract-management process, and make any necessary improvements.

Contract Management - Best Practices