- February 24, 2024
- 15 min read
- BETHANY MULLINIX
Introduction
Business success hinges on forging and maintaining strong relationships with partners, clients, and suppliers. What starts as a phone call or email can develop into partnerships that span decades.
Managing contractual obligations – the terms on which contracts are built – is central to preserving business partnerships. Consistently fulfilling them can enhance your reputation as a good business partner and set a foundation for new opportunities.
On the other hand, failing to do so can lead to a host of business issues, from financial losses to strained relationships and even legal disputes.
Let’s look at the critical aspects of contractual obligation management, examining what they are, reviewing some common types, and understanding what can happen if you mismanage them. We’ll also explore how technology – particularly AI contract analysis and Contract Lifecycle Management (CLM) software – can help manage your obligations and improve business outcomes.
What is a Contractual Obligation?
Contracts are the backbone of business agreements. They begin when a duty is promised from one party to another and provide a clear set of rules and expectations for all parties involved.
At the heart of these agreements lie contractual obligations or the parts of a contract that spell out each party’s responsibilities – what they promise to do or not do.
For example, if you sign a business contract with a digital security provider, you are responsible for paying them for their services at specified intervals. The provider must supply you with digital protection services for the duration of the contract.
When are Contractual Obligations Formed?
Contractual obligations are formed when two or more parties sign a contract, either physically or digitally.
Prior to signing, the parties develop and agree to the contract terms. They must also agree on the “consideration” that will be exchanged, such as money, goods, services, or even a promise to perform or refrain from a certain action.
Once they accept the offer, the obligations begin, and the offer becomes a binding contract.
Are They Legally Binding?
Yes, contractual obligations are legally binding. Once signed, both parties must uphold the terms and conditions outlined in the agreement. Failure to fulfill these obligations can lead to legal consequences, including breach-of-contract lawsuits.
4 Things Most Obligations Have in Common
Contract obligations vary based on contract type, industry, and each party’s requirements. But in general, most contract obligations include terms on:
- Delivery – What goods or services will be delivered and the timeline for delivery
- Payment – What will be paid for the delivery of the goods or services and when
- Quality – What are the expectations for the condition of the goods or how well the services must be done
- General requirements –Often, how the parties will act under the terms of the contract
Examples of Contractual Obligations
Contractual obligations are key in employer contracts, real estate purchase agreements, vendor contracts, licensing agreements, union contracts, franchise agreements, mergers & acquisitions, and investment term sheets.
Here’s an example of how contractual obligations might work in a vendor procurement contract:
Let’s say Ellen, a procurement manager at South Shoal Hospital, needs to hire a cleaning service to maintain the hospital’s floors. She hires Jim, who runs All-Star Cleaning and Maintenance Service. After a meeting and a few emails, they agree to the following:
- All-Star Cleaning and Maintenance will clean all floors twice each month and heavy traffic areas (lobby and cafeteria) four times each month for one year. Services include basic cleaning, removal of scuff marks, sanitizing, and polishing.
- All-Star Cleaning and Maintenance will submit a monthly invoice of $580 to South Shoal Hospital, who agrees to pay the invoice within 30 days of receipt.
- If All-Star doesn’t stick to the cleaning schedule or the level of cleaning is unsatisfactory, South Shoal Hospital can withhold payment until All-Star meets the contract terms. The hospital can also terminate the contract if services are late for two or more months.
Types of Obligations
Contractual obligations aren’t one-size-fits-all – they’re unique to each situation and the parties involved. However, most of them have common elements, including terms for:
- Delivery – When and how goods or services will be delivered.
- Payment/Consideration– How much and when payment for the goods and services is due.
- Performance – The standards and expectations around providing goods or services.
- Penalties/Refunds – What will occur if the goods or services don’t meet expectations or aren’t delivered as promised.
- Statute of Limitations – A limited time frame during which a party can enforce their rights under a contract.
- Termination – The conditions under which either party can terminate the contract.
- Non-Compete or Disclosure – Clauses restricting parties from competing in the same market or disclosing sensitive information to third parties
Risks of Poorly Managed Contractual Obligations
Now that we’ve established the importance of contractual obligations, let’s look at the risks associated with poorly managed obligations and failing to fulfill your agreement. These can include:
- Financial losses – This includes a disruption in production and can impact your bottom line.
- Legal consequences – Breach of contract can result in costly and time-consuming lawsuits.
- Strained business relationships – Any broken promise erodes trust and causes partners to seek alternative arrangements.
- Operational disruptions – Disrupting day-to-day operations leads to inefficiencies and a potential loss of income.
- Damaged reputation – Contract breaches can tarnish a company’s reputation and deter potential partners.
- Drained company resources – Resolving contractual disputes requires significant resources, including time and money, which you could better spend on growing the business.
- Loss of Competitive Advantage – Public disputes over contractual obligations can reveal weaknesses to competitors or potential customers.
Taking Action on Non-Fulfillment of Contract Obligations
If you or a business you’re under contract with can’t fulfill contractual obligations, it’s essential to take action as soon as possible to mitigate potential loss or damages to your business and your reputation.
What if you can’t fulfill a contractual obligation?
If you can’t fulfill your contractual obligation, you could be in breach of contract, leaving you open to possible legal action and financial damages. What should you do?
Your first step is to carefully review the contract. Look for a “right-to-terminate” clause, which may allow you to terminate the contract early if appropriate conditions are met.
Next, communicate the situation with the other party. This can go a long way toward minimizing the impact of an unfulfilled obligation. Be open and transparent and come to the table with realistic solutions.
If necessary, consider renegotiating the contract terms to accommodate unforeseen circumstances, especially if those circumstances are ongoing. Also, consider seeking legal counsel to understand your options and potential consequences.
What if someone else is in breach of contract with you?
If the other party is in breach of contract, you can use the same strategies to help alleviate the situation and minimize the damages.
Review the contract to verify the breach is clear and that the other party is indeed in violation. If the contract includes a right-to-terminate clause, consider how that could impact your business and research other means of receiving the necessary supplies or services.
Then communicate – contact the other party to discuss the breach and attempt to resolve the issue amicably. Perhaps you can agree and amend the contract. If those resolution efforts fail, consult with legal counsel to explore legal options, such as pursuing damages or contract termination.
How do You Track That Obligations are Being Met?
Good communication and recordkeeping can be your most important contract tools. To ensure that both parties consistently fulfill their obligations, consider implementing the following strategies:
- Set Clear Dates for Expiration and Renewals. Clearly define the contract duration, spell out expiration and renewal dates, and establish processes for renegotiation well in advance.
- Keep documents and records up to date. Maintain meticulous records of all contracts and their associated obligations. Ensure that all parties have access to these records for reference.
- Perform regular contract audits. Conduct periodic audits to assess compliance with contract expectations and promptly address deviations.
- Train team(s) on their roles and responsibilities. Educate your team members about their roles and responsibilities in meeting obligations. Training can help prevent misunderstandings and improve compliance and successful outcomes.
How AI Contract Analysis Supports Obligation Management
Technology now plays a pivotal role in contract management – and it can make managing your contracts much easier. In particular, AI-powered contract analysis can reduce human error, enhance efficiency, enable reminders and alerts, and generate business insights.
Check out our blog on how AI contract analysis works to learn more.
Strengthen Your Business Agreements and Obligation Outcomes With CLM Software
CLM software is a powerful tool for managing contractual obligations effectively. It automates and simplifies the contract management process by:
- Streamlining the process from creation and negotiation to execution and contract renewal by swiftly reviewing vast amounts of contracts, identifying key obligations and terms, and interpreting and categorizing them.
- Improving visibility into contract data, enabling better tracking of obligations and performance by generating insights about which terms or obligations are most commonly met, breached, or negotiated.
- Reducing risk by identifying and mitigating potential issues
- Enhancing compliance by reducing the likelihood of breaches with automated reminders and real-time alerts if there’s a deviation from the agreed terms or if a deadline is approaching.
Benefits like these can help you better manage contract terms, helping to keep operations running smoothly and business relationships strong.
Ready to learn how Sirion’s CLM can work for your business and improve your contract outcomes? Request a demo today!
Additional Resources
What is Contract Lifecycle Management? Looking Inside CLM
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