One of the most important elements of the control environment is any business is the establishment and use of formal policies and procedures for reviewing and approving contractual arrangements with third parties that will create legal rights and obligations for the company. Ideally some sort of contract review and signature authority policy will be put in place very early in the company’s existence since contracts of various types will be needed from the time that the company first opens its doors. Many times all of the contracts under consideration during the start-up phase will be discussed by all of the founders because it easy to do so in light of their close proximity and the absence of layers of management personnel when the company is still small. The problems begin to arise, however, when founders and other senior managers start to assume more responsibility for particular areas of the business and the input from other founders and managers becomes more limited due to the lack of time, problems with communication and the fact that the other persons are themselves preoccupied with their own projects. While the senior managers in a particular functional or business area presumably have the most skill and experience with respect to contracts that they initiate it is nonetheless important to have some independent review of the business case for the contract and the potential risks to the company of assuming the legal and operational obligations included in the contract. For example, all functional areas that might be involved in fulfilling the company’s duties under the contract should be consulted in advance to verify that they will be able to perform as anticipated. Contract review is also necessary to avoid conflicts with commitments that someone else in the company may have already made with other parties. Finally, contract review is needed to be sure that independent parties are reviewing the terms of each proposed transaction and that persons initiating a contract do not have some “vested interest” in the selection and use of the contract partner. In the next few posts I will discuss some of the legal and practical considerations that should be taken into account in creating and administering procedures for contract review.
The content in this post has been adapted from material that will appear in Business Counsel Update (July 2008) and is presented with permission of Thomson/West. Copyright 2008 Thomson/West. For more information or to order call 1-800-762-5272.