Understanding Contract Analysis
Contract and document analysis is the process in which lawyers review and analyze contracts, documents and agreements that you have received from any form of your client’s transaction for the purpose of determining potential red flags, reviewing key clauses, and negotiating terms with the other party to the contract. Contract analysis should be done at or before the time the contract is signed to ensure that the contract accomplishes the goals of the parties entering into the contract. An example of the impact of a failure to complete contract analysis may be the case in which you are suing on a contract, and the other side then argues that the contract is not enforceable at all because you missed a requirement in that state’s laws on what language has to be in the contract to be enforceable. The lawyer that did not complete contract analysis in that case very likely lost the case for their client who simply did not get the protections they thought they were getting by signing the contract.
Contract analysis is a critical part of practicing law because the analysis of the documents ensures that lawyers draft pleadings , motions and agreements correctly so that clients get the results that they want from their time with their lawyer. But, contract and document analysis is important for business people too – your company may need a contract with a client, a supplier, a purchaser of goods, real estate, an employee or an independent contractor. In any of those situations, you will want the contract to protect your rights, provide clarity on the expectations of either party under the contract, and to evaluate when the contract will terminate and how the parties can go their separate ways. This importance will often require that you seek professional help to negotiate a contract with the other party, or the help to ensure that the documents that are drafted meet your requirements.
Components of a Contract Analysis
The key elements to contract analysis are to first identify the parties to the contract, then to determine what the key terms are of the contract. Once you have the parties identified and the terms that you are especially focused on, then you need to either read through the contract while highlighting those terms or edit them to highlight the terms. Once your highlighting has been accomplished, you will then review the contract for risk – determining if you are defaulting, if you are entering into terms that may be in violation of the law, and so on. Almost anyone can pick a contract apart and find anything that they feel is a problem, so it is important to have someone who has been trained in how to find risks in contracts to go through them to work to manage or mitigate those risks. Once you are satisfied that all or most of the risk has been managed or mitigated, then make sure that you are in compliance with federal and state laws, determining if you need to file or take any other action to bring your entity or individual into compliance.
Common Approaches for Contract Analysis
Contract analysis can be a time-consuming process, especially for large volumes of contracts. Leveraging technology and software solutions can help professionals to streamline the process, reduce risks, and ensure compliance. The following are some common methods for conducting contract analysis.
Contract lifecycle management (CLM) software is increasingly being used to streamline the contract management process. By providing a centralized location for storing and managing contracts, CLM software helps professionals to easily access contract information, track changes, and collaborate with team members. Some CLM software also includes features for automating contract review and approval processes, as well as tools for analyzing contract data for better reporting and insights.
Contract analytics software can help professionals to quickly and accurately analyze contract data, identify potential risks and opportunities, and make data-driven decisions. Contract analytics software typically includes features for data visualization and reporting, as well as tools for identifying trends and patterns over time.
Some companies and organizations use contract repository software to store and manage their contracts. This type of software typically includes features for organizing and categorizing contracts, as well as tools for searching and filtering contract data. By using a contract repository, professionals can quickly and easily find the contracts they need and avoid unnecessary delays and interruptions.
Contract auditing is another important method for analyzing and evaluating contracts. During a contract audit, professionals review contract documents to ensure that they comply with legal and regulatory requirements, as well as internal policies and standards. Audit teams may also analyze contract data for compliance or performance metrics. Contract auditing helps to identify any noncompliance issues or contract breaches, allowing companies to address the matter proactively.
Whether you are looking for a software solution or an analytical technique, there are plenty of effective ways to analyze your contracts. Depending on the target audience, you may prefer to use a contract repository to gain insights into contract performance or contract analytics to assess the nature and scope of contracts. Contract audits can also help you to review existing contracts for compliance and best practices.
An Example Walkthrough of Contract Analysis
For example, say you were going to sell a boat, and your friend, Dave, was going to buy the boat, but you are not really sure about the value of your boat, nor have you bought or sold many boats before:
THE BOAT:
You and Good Friend Dave both enter into the following Boat Purchase-and-Sale Agreement:
"Agreement between Purchaser and the Seller,
Purchaser is buying and Seller is selling the following boat:
‘Boaty McBoatface,’ a 1994 Mustang 205S, in good condition and with an excellent motor, with trailer, with a new life jacket that passes marine safety standards.
The purchaser offers and agrees to buy the above-described boat for as follows:
- The price for the above-described boat is $10,000.00.
- Purchaser will deliver a deposit in the amount of $5,000 today.
- The Purchaser will pay the remaining balance in thirty days from today."
Signed and dated this day _____________________.
SIMPLE ANALYSIS:
The above contract is a simple, straightforward contract to buy a simple boat.
You basically say that you are selling him a boat according to all the items described above.
And you and Good Friend Dave agree to $10,000 for the boat, with $5,000 down. Pretty easy.
You both even tackle the most important issues up front – the price and the item being sold!
IMPORTANT POINT:
Many times, especially in business contracts, people seem to write contracts with a two-sentence throwaway clause, like "the parties agree to do something sometime later."
And then, when the time comes to enforce the contract, you cannot figure out which parties, or which something, or at what time, was agreed to. But that is not the case with your purchase contract.
So congratulations, you and Good Friend Dave have successfully contracted for the sale of your boat, Boaty McBoatface.
APPROXIMATE LEGAL ANALYSIS:
First, we hit the contract with a rule-based analysis (the black-letter analysis).
- Is the agreement a "contract" under the law for contracts?
- Was there an intention to create a legal obligation?
- Terms that include an agreement to buy a boat and $10,000.
- The subject is both parties.
- Both parties have the power to contract.
- Both parties are of sound mind.
- And all the elements for a contract are met. That is, the existence of a contract arises where a competent legal party enters into a bargain, with the intent to act legally, which is an offer, and acceptance of that offer, where the people who make the offer and acceptance on behalf of the parties are authorized so to act.
- All subject matter is legal, including the agreement.
- And the contract is clear – to an outside party, without explanation necessary.
- There’s a definite and reasonable amount of money involved ($10,000).
- The subject matter is capable of performance. In other words, there is a boat in good condition.
- There is consideration. And the consideration is the $10,000.
- All parties are of the age of majority and sound mind, and can make a contract.
- All parties are present or represented at the time of the making of this agreement.
- There are no deficiencies in the fact that you don’t have a notary public, as no notary is necessary for the making of this agreement.
- (And so on.)
And so – even without talking over your contract with a lawyer, the above analysis seems pretty simple and straightforward. You are selling a boat for $10,000 and you agree. You agree in a way that is understandable to an outside person, and that fully explains terms, conditions, and sets all parties in motion to complete the contract.
Congratulations! You have successfully completed a contract with your Good Friend Dave.
Challenges and Common Errors in Contract Analysis
When it comes to contract analysis, understanding what to look for is only part of the battle. There are pitfalls that can cause an incomplete or inaccurate evaluation and that can lead to contractual obligations being overlooked or misread and which can result in costs or a negative outcome for your company.
Analysis pitfalls
First, all definitions must be found. It’s absolutely essential that you find all words in a contract that are defined. Some contracts have definitions that have been incorporated by reference from another document. One word could have several definitions. Don’t just look at the definitions section of the contract. You need to find the definitions for yourself. This involves being vigilant about researching things such as industry words or phrases, other contracts, statutes, those second definitions, and what other words might refer to that one word. For example, the word ‘best’ could be used to denote many things, but when it refers to a product, it could mean something very specific.
Second, the contract and provisions must be read carefully and completely. Every word must be analyzed to determine its true intention. While you may think you get the gist of something, you will not fully understand it unless you read every word. The overall objective of the negotiation may not be the same as the objective of each provision. Furthermore, sometimes the entire document does not match the word of mouth agreement. In a verbal or written agreement, the parties may agree to a certain one thing, but when you read the actual words, they aren’t in agreement with the intention. You cannot go based on the parties’ understanding and agreement—the bargaining heritage—of what the contract means or wants. The analysis must be based on the actual words, and not just the intent .
In addition, don’t just rely on standard language. Sometimes you only see what you are accustomed to seeing. It’s the contract you always attach to a deal, and you just insert your parties’ information. Be prepared for contracts that have unusual or atypical clauses and that do not contain clauses that you have come to expect. Don’t just sign something you did not properly analyze. Check if it contains certain things you haven’t seen before or are not used to. One mistake would be to not even read the contract because you are just going to attach your usual agreement. It’s important to carefully read the entire thing, and not just skip to the end to sign it.
Another pitfall is failing to examine and analyze the terms and provisions. Many people forget to look for exceptions and qualifications. One example of an exception is the words, "excluding wear and tear." A good example of qualifications is: "unless approved by the board." Another one is: "in accordance and consistent with." Make sure you are reading the words, not just the intent.
Identifying the unknown
In addition to what’s in the contract, there are things you don’t know that you don’t know. You won’t discover the unknowns until much later, and when it’s too late. You won’t know you don’t understand something until years, even decades later. Fortunately, there’s a solution. To uncover the unknowns, perform a gap analysis of what you don’t understand and what you think is the unknown. Then, you can at least partially address the unknowns. Conduct due diligence on the language to discover the unknowns. This can involve surveys of the market conditions, talking to other people, consulting other contracts, performing research, and more.
Best Practices for Contract Analysis
Best practices in contract analysis involve a combination of using technology and relying on the knowledge and expertise of trained legal professionals. These best practices can ensure that contract analysis processes result in high-quality data, meet deadlines and save time and costs. It is vital for legal professionals to analyze contracts to discover and document key provisions.
Focusing on understanding the wider context in which the contract was negotiated can be more productive than obsessing over every detail. Contract analysis is more effective when context is given priority. Understanding why specific provisions have been adopted and which parties were behind them is invaluable. Unless you appreciate the intent of a clause, you may underestimate its significance. Moreover, it may not be consistent with the overall agreement. For instance, if you miss the point of a particular obligation and it is breached, you may not realize your organization has suffered a loss.
Contract law is about recognizing when you need to pay attention to details. Sometimes specific clauses are extraordinarily important. Why did the contract include a particular definition? Is it consistent with what you could reasonably expect? Are there words in the definitions that are not commonly used or understood? Does the contract include legalese that intentionally obfuscate the meaning of a provision? Why is someone trying to be ambiguous?
The scope of the work undertaken by parties in contract analysis is informed by their experience. They typically will focus on determining which clauses are most likely to result in a dispute. In addition to anticipating the various circumstances in which provisions can become relevant, legal professionals focus on contractual risk. However, legal professionals also recognize that contractual risk is a burden that can be managed rather than be avoided. Implementing a risk management plan is also part of the process of analyzing a contract.
Legal professionals also rely on checklists. There may be a checklist for standard clauses, one for the typical terms or even one with all of the key provisions in a contract. Relying on these tools can help ensure that contract analysis does not miss any important components.
Emerging Trends in Contract Analysis
Looking ahead, contract analysis is set to undergo substantial transformation driven by advances in technology, including artificial intelligence (AI), natural language processing (NLP), and machine learning. These tools offer powerful new options for contract examination and analysis, pushing the envelope in terms of what is humanly possible and making critical insights accessible in ever-shorter timeframes.
The ongoing revolution in machine learning is shaking up contract examination like never before. AI promises to replace human lawyers in areas where sophisticated analysis is necessary, such as general counsel review, contract negotiation, executive hire analysis, and merger and acquisition due diligence. In short, fully automated contract examination is on the horizon.
Contrary to some perceptions, the advent of machine learning in contract examination does not render human contract review obsolete. On the contrary, the human touch is central to this process. One recent development brings this fact into sharp relief: NLP, or natural language processing. As the Journal of Emerging Trends in Computing and Information Sciences reports, NLP is an area where AI and law intersect in a profound way. NLP-based contract examination includes intelligent categorization, identification of key clauses, and semantic analysis to uncover ambiguities that might have otherwise gone unnoticed. The Journal explains that this approach makes sense for machine-learning-assisted contract examination, as the majority of contract text is written in natural language. NLP harnesses industry-specific datasets to improve the accuracy and efficiency of contract examination function. By way of example, natural language processing can be used to categorize contracts through analysis that builds on long-held business rules and requires no human intervention .
One of the central drivers of contract examination includes the availability of datasets that permit machines to learn over time and gain the kind of experience no human contract examiner could ever hope to get. As a result, machine learning for contract examination is poised to advance at an exponential rate. With that said, simply adjusting machine learning algorithms will not be enough. Instead, the future of machine learning for contract examination will require new ways of organizing and laying out data. And indeed, as research from the Massachusetts Institute of Technology, the University of California at Berkeley, and Stanford University shows, AI promises to make contract reading faster and more intuitive than traditional methods.
As machine-learning algorithms improve, AI will expand the range of benefits that flow from computer assistance in contract examination. New tools will help narrow down relevant components in contracts and increase visibility on risk factors. AI will enhance the efficiency of contract examination, enabling far more deals to be examined in a shorter period of time than is currently possible. This may lead to a paradigm shift in how type of contract examination is done, leading to a more streamlined approach and higher fidelity in examining complex contracts.
As the current crop of contract examination tools matures and AI continues to make headway, organizations will be likely to encounter new contract types. Most notably, smart contracts are gaining traction, and may someday rival conventional contracts as preferred means of transaction. Given the rise of smart contracts, technology-strapped legal departments would be wise to use leading contract examination tools to equip themselves for the future.