How to Review and Negotiate a Contract

Contracts are the lifeblood of business. When you sell your product or service to a customer, you enter into a contract. When your business buys something, such as software, services or a new coffee machine, you enter into a contract.

But the process of reviewing and negotiating contracts can be problematic, leading to delays in the sales or procurement cycle, damaging relationships and reducing an organisation's ability to seize opportunities and capitalise on them.

What is the contract review and negotiation process?

A contract review is the process of checking the terms of a contract to make sure they align with your business’ preferred commercial and risk positions. For example, do the commercial elements that are in the agreement  align with what you’ve agreed? Are you comfortable with the liability cap the other side has proposed?

Often, the contract management function (Legal, Contract Managers or Procurement Officers) will be encumbered with making decisions on these parts of an agreement when they had no part in the commercial negotiations that preceded the contract. A lack of involvement in the contract review and negotiation process from the wider business is often why delays are caused but this can be avoided with the right level of training and governance.

Having said that, it is often the case that the function that’s responsible for contracts hasn’t done the necessary groundwork to frontload the effort required to understand and document the organisation’s preferred positions or risk appetite. The best way to do this is through contract review and negotiation playbooks. If that’s the case then that function will often be forced to make ad hoc decisions, thereby creating an inconsistent contractual landscape.

This also encourages delays as the right approvals need to be gathered during the contact review and negotiation process which means there is a dependency on others and their availability to engage with the process and provide their responses.

Why do you need to review and negotiate contracts?

In every commercial relationship, there will be a balance of risk and reward. The contracts function is responsible for ensuring that the risks included in an agreement are balanced and proportionate to the reward.

For example, if you’re entering into an agreement that is of zero monetary value to you in the immediate (for example, if you’re a software provider offering a prospect a free trial) but have an unlimited liability cap that could open your organisation up to significant financial loss, then the risk / reward ratio is most probably imbalanced and the contracts function needs to take steps to even the balance out such as amending the agreement so liability is capped.

In other instances, contracts include risks you are prepared to take but need to take steps internally to mitigate their impact if those risks materialise. For example, the other side might be given access to your data or intellectual property.

You need to understand what exactly is being shared and how you can take operational steps to reduce the potential risks the contract poses, for example, informing stakeholders about their obligations and introducing appropriate controls and measures.

How to review a contract

To review a contract and evaluate its risk, there are 4 things you should be thinking about:

1. Who is the other party? It’s important to know who you’re contracting with, whether your organisation has already undertaken due diligence on them, what their business is and whether there’s anything you need to know about them which may influence the way you review the agreement. For example, if you’re contracting with  AWS or Google it’s unlikely you’ll have much bargaining power unless you’re an equally large organisation so it may not be worth spending the time redlining an agreement in detail and inviting them to negotiate. On the other hand, any concerns about their good standing and their ability to deliver should be limited.
   
2. What is the contract for? It’s often the case that the contract function reviewing an agreement does not have the relevant information or knowledge to properly assess the risk associated with an agreement. To bring this to light, if you’re buying a coffee machine once, the chances of anything going wrong or significant risks to you are pretty slim, even if the contract is badly written and not in your favour. The same can’t be said if you’re sharing a significant amount  of data, intellectual property or it's a high value contract: in that case, you’ll want to make sure you have robust contractual protections in place to protect your organisation.
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3. What’s your organisation's approach to risk? If you’re a bank for example, your risk tolerance is going to be a lot lower than a company that sells water bottles. Understanding what your organisation can accept is fundamental to determining whether or not you need to negotiate. Ideally, your risk appetite should be documented clearly and granularly in a contract review and negotiation playbook and signed off by the right levels of authority within your organisation.
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4. Look out for the key provisions. More on what those provisions are here, but if any of these don’t look quite right based on who the counterparty is, what service you’re buying and your organisation's approach to risk, then you’ll most likely want to negotiate.

In conclusion, the process of reviewing and negotiating contracts is a critical aspect of safeguarding a business's interests. It requires a delicate balance of understanding the risks involved, the nature of the other party, and the specific needs of the organisation.

By developing clear strategies and guidelines, such as playbooks, and engaging in informed negotiations, businesses can effectively manage risks while maximising opportunities. Ultimately, thorough but efficient contract review and negotiation are indispensable tools for any organisation aiming to thrive in the competitive world of commerce.