Contract Review–Two Main Purposes

I am in the process of discussing contract review procedures.  In order to be effective, procedures for contract review and signature authority should accomplish at least two main purposes—establish the process for the review and approval of proposed contracts by various departments (e.g., legal, finance and other departments involved in the fulfillment of obligations created under the contract) and identifying which persons within the company have the authority to approved specified transactions or activities and thus execute a proposed contract on behalf of the company.  Ideally the contract review process will also provide an opportunity for evaluating the proposed contract in the context of the company’s overall business strategy.  This can and should occur through the creation of a business case for each proposed contractual arrangement (or at least those contracts that are “material” in light of the company’s business) that describes the key rewards and risks associated with the contract, explains why the contract is important to the company’s business plan, establishes performance milestones, and suggests procedures for monitoring performance under the contract after it is executed.  The business case process forces the initiating party to think through each proposed contract and become an informed internal champion for the relationship and also serves as an important information and communication tool for senior management to the extent that they are being kept in the loop as to the specific activities and tactics that are being used to further the company strategy that has been established at the top of the hierarchy.

Creating signature authority, including delegation of authority downward in the organizational structure of the company, is particularly important as the business grows and the company adds management layers and the number of employees multiplies.  When the company is small almost all new contracts should be signed only by the president or chief executive officer of the company after review by the senior managers responsible for the departments that will be involved in fulfilling the company’s obligations under the contract.  As time goes by, however, authority to sign contracts can and should be formally delegated by the president and chief executive officer to competent officers and managers within the company subject to specific conditions and limitations defined in the delegation instructions.  In all cases, for example, authority to sign contracts should be conditioned upon creation of a written record that all steps in the review process have been completed (e.g., review and approval by other interested departments).  Delegation of authority is generally limited to contracts that do not create a financial exposure for the company that exceeds specified amounts.  For example, a department manager may be allowed to commit the company to provide cash or services up to $50,000; however, any commitment above that amount would need to be reviewed and executed by someone more senior in the hierarchy.  Business relationships with third parties based on “standard contracts” that have been drafted by the company’s legal department may also get “fast track” treatment and not require separate review by the legal department.  Managers may also be given more leeway to enter contracts that have been previously anticipated in the business plan and budget for their particular department provided that the managers have complied with other requirements with respect to solicitation of bids and proposals for contracting.

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.

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