4 Most Important Types of Contracts to Your Organization
When looking to improve your contract management processes, it helps to know the contract fundamentals before diving into advanced topics like best practices. Although you are likely knowledgeable about the types of agreements your organization currently uses, there might be others you have not executed — those that could better define your relationships with suppliers, customers, partners, and other parties with whom you do business.
What is a contract?
A contract is a binding agreement between parties, such as businesses, people, or two or more people. It defines the obligations of each party to the other, including the following:
- Delivery of products and/or services
- The quality of those products or services
- The beginning and end date of the agreement and any renewal terms
- Requirements for relationships, like employment, partnerships, mergers, or acquisitions
Contracts also define the remedies that are available if one or both parties fail to meet their obligations, like contract termination, legal action, or financial ramifications.
So, choosing the right contract types for your organization is critical. Some contract types carry a higher level of risk than some organizations cannot afford to take on. Others are best suited to parties who know each other well and have built a high level of trust.
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Why are contracts important?
Contracts are important because they provide a legal record of an agreement between two or more parties — as to their understanding of their obligations and expectations. When individuals or authorized business or institutional representatives apply their ink or digital signatures to a contract, they — or the business they represent — are legally bound to fulfill the terms of the agreement.
It does not matter whether an organization’s legal department, contract management team, senior executive, or virtual AI assistant has reviewed a contract — and understands its terms — in its entirety or not. In the eyes of the law, a fully signed and delivered contract means all parties to the agreement are required to comply with the terms of the agreement. (Of course, we hear about situations where one party doesn’t comply – that’s called “breach” and it’s the source of many lawsuits.)
4 Different Types of Contracts
1. Sales Agreements
Generally, sales agreements govern the sale of products between businesses, like raw materials, supplies, or equipment. They can, however, include services, such as when a Statement of Work is included as an addendum. Companies need to ensure their contract terms are followed to the letter in order to recognize revenue for a fiscal period. So, using approved templates is a best practice.
Terms of sales agreements include the following:
- Pricing, including volume-based discounts
- Payment terms, such as incentives for early payment
- Return policies, including return merchandise authorization terms
- Delivery terms, including free on-board or point of origin
- Warranty, including repair or replacement options
Ultimately, sales contracts can govern a one-time order or multiple transactions over a defined time period.
2. Non-Disclosure Agreements and Intellectual Property Management
There are many types of relationships when non-disclosure agreements (NDAs) are used. For example, joint venture partnerships are when two companies bid on a government tender together — with the commitment that they will not divulge each other’s methods or industry secrets. Employees and contractors often sign NDAs during their onboarding process. Companies typically maintain NDA templates that cover their most sensitive information and the circumstances which put it at risk.
When your company is considering signing another party’s NDA, be sure not to commit too much before you have done your due diligence. Ensure the NDA does not bind your firm to the other party in terms of risk or obligations before you know exactly what each party brings to the table and is liable for in the business relationship. Legal teams should watch out for third-party access rights, and the information that should be treated as confidential and non-confidential. Employment NDAs, for instance, cannot prevent whistleblowers when laws are broken or there are serious ethics breaches.
In this digital age, industries — like manufacturing, software companies, and pharmaceuticals — are just a few in which intellectual property protection is crucial to growth and competition. Management of copyright, trademark and patent-related portfolio data empowers your legal team to mitigate risks, like brand reputation damage, loss of revenue, and frivolous lawsuits.
3. Professional Service Agreements – Fixed-Price, Time and Materials, and Retainer-Based Contracts
There are many kinds of professional services contract structures, and each has its own strengths and weaknesses. Fixed-price contracts are often used for government consulting and construction projects. Generally, they are best suited for large firms that have a higher appetite for risk and are skilled in scoping out large projects. They require “all-in” bids, including expenses and costs to supply all of the deliverables.
Fixed price contracts can return significant margins if the service provider strikes a balance between contingency, ability to deliver, and project management. But deliverables must be thoroughly described and agreed to by both parties, and scope change management must be handled with care. Interestingly, companies that can absorb the risks involved with fixed-price contracts often find themselves at a competitive advantage over service providers that are only comfortable with time and materials, or cost-plus contracts.
Time and materials or cost-plus
Time and materials (T&M) contracts enable service providers to bill based on per diem or hourly work performed, as well as the expenses. Thank travel, meals, supplies, and other quantifiable costs. The client assumes most of the risk of cost increases beyond the initial statement of work, which can prolong negotiation time. Consulting, application development or construction companies that work under T&M contracts should ensure their statements of work (SOWs) and master services agreements (MSAs) have clear, concise language and a well-defined change management methodology.
Professionals — like consultants, freelance marketing professionals, and consultants — have followed the lead of attorneys in adopting retainer contracts to provide their services. Retainer-based contracts can be lucrative for service providers when a client does not require much of their time or skillset.
But it is important for any contractor to set a “cap” on their monthly obligations, so they can bill at an agreed rate if a client requires more of their time than is reasonable or profitable. Negotiating whether a “bucket” of hours or days can roll over or not is one way to mitigate utilization peaks and valleys, not to mention the risk of neglecting other clients from time to time.
Naturally, each of these service agreement types has advantages and disadvantages to certain business sizes and categories. So, clearly defining the deliverables and obligations of each party — including milestones, payment schedules, and change management — is essential.
4. Adhesion Contracts
Many business contracts have terms that buyers or partner candidates can accept or not. These terms are non-negotiable, and are best suited for templates and accelerated transaction workflows. Typical examples of adhesion contracts are clickwrap or browsewrap agreements – the kind we see when installing software or using websites.
Leverage an Intelligent CLM to Manage Your Contracts
An AI-enhanced contract lifecycle management (CLM) platform can help your organization streamline workflows for authoring, negotiating, approving, storing, and finding business agreements. Leading, richly featured CLMs provide features and benefits like the following:
- Predictive and real-time analytics for businesses to identify contract trends and anomalies, and to take corrective or sustaining action as needed
- Templates to make use of approved contract language and reduce the likelihood of costly human errors
- Workflow automation based on pre-defined criteria and parameters
- Virtual contract assistant functions to review in-house or third-party contracts before they are signed with digital or ink signatures
These are some of the most common contract types which your business is likely already using. If you are encountering specific challenges with these or other contract types, and are interested in addressing them, let’s get in touch.
ContractPodAi helps many organizations worldwide address difficult challenges in their contract workflows. Contact us today. We would be happy to help you benefit from our proven solutions and expertise.
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