Contract review - the way to automation

Contract review is much more than a formality - it is the decisive step in ensuring legal certainty and clarity between the contracting parties. An inadequately reviewed contract can not only be legally ineffective, but can also have serious consequences if misunderstandings or disputes arise.

Whether it's a mobile phone provider, streaming subscription or rental contract, we already know how expensive inadequately checked contracts can be in our everyday lives. Studies shows: Many Germans find themselves in a veritable contract loop, usually without a complete overview. While this is annoying in private life, it can quickly become a threat to a company's existence in a business environment.

In the corporate context, the consequences are quite different: inadequately checked contracts can cause serious financial losses, legal risks and operational disruptions. Therefore, a thorough contract review before signing is essential in order to avoid legal pitfalls and economic disadvantages.

According to a recent McKinsey study, the use of generative artificial intelligence (AI) can significantly increase productivity, even in areas that require complex specialist knowledge. Up to 55% of tasks can be automated using AI, leading to a significant increase in efficiency and a reduction in workload. The study also shows that AI tools can provide companies with targeted support in identifying potential in existing contracts.

In this article, we shed light on the importance of a structured contract review, provide a practical checklist and show how companies can intelligently automate the review process with the help of AI.

In short: Why do you need to review contracts?

The review of contracts is a guarantee of legality. If a contract is illegal, it is legally considered null and void. If one of the contracting parties then breaches the agreement, it can neither be compensated nor held liable. Contract review prevents this and ensures that the contract contains all the necessary elements.

In addition, reviewing the contract can help to avoid misunderstandings. Parties may interpret the terms differently, which can lead to an inadvertent breach of contract and result in litigation. A contract review will ensure that both parties signing a new agreement have a consistent understanding of the terms. At the same time, a comprehensive review can highlight areas for improvement and uncover sections that could adversely affect the parties.

Overall, the purpose of a contract review is to ensure that the legal agreement and its provisions are sound and that legal and financial risks are minimized.

Who should review contracts?

Contracting parties that can be included in the contract review process are:

The legal department: In companies with their own legal department, this is the central point of contact for contract review. It ensures that all legal requirements are met, minimizes risks and supports other departments in drafting, reviewing and negotiating contracts.
Corporate departments such as purchasing, HR or sales: Depending on the type of contract, the relevant specialist departments should also be involved. Purchasing, for example, checks supplier contracts with regard to pricing, delivery conditions and quality requirements. The HR department is involved in employment contracts or service contracts with freelancers. Sales, on the other hand, has a particular interest in customer contracts, discounts, payment terms or delivery commitments.
The counterparties review the proposed contract to ensure that the risks and the legal and business implications of the contract are favorable to them. They may propose changes and negotiate with other parties.
Contract specialists or legal counsel: It is considered best practice for a contract specialist or legal counsel to review the contract after each round of negotiations and before it is signed by both parties. They are responsible for ensuring that the contract meets the legal requirements and provide legal advice.
In-house director or executive: Larger companies may have in-house directors or executives who are responsible for reviewing contracts to ensure they align with company strategy and interests.
Lawyers or contract lawyers: Lawyers can provide legal advice and expertise to help the company draft contracts legally and fairly. They can assist in the drafting and negotiation of contracts.
Suppliers, customers, employees, contractors, investors and lenders: In principle, there are a lot of stakeholders with whom a company can enter into contracts. It is important for companies to review contracts to ensure that their interests are protected or that contracts are amended to meet their needs.

On an individual level, people and consumers may also need to review contracts, such as real estate purchase and sale agreements, employment contracts, prenuptial agreements and estate planning documents. They may hire a lawyer to review contracts on their behalf and provide legal advice.

What to look out for in a contract review?

Various aspects should be carefully considered when reviewing a contract. First of all, this includes the clarity of the contractual clauses in order to avoid misunderstandings and room for interpretation. It is equally important to clearly define the rights and obligations of the contracting parties. It is also important to check whether all legal provisions have been complied with. Essential elements of the contract should be included completely and correctly. It is also important to identify potentially ambiguous wording or risks. Finally, an assessment of the enforceability of the clauses and the dispute resolution methods provided for also plays a decisive role.

Checklist for the contract review

When conducting a contract review, it is helpful to start with a plan so that you can be sure that the essential parts of the contract have been carefully analyzed. If errors or inconsistencies are found or problems arise during the contract review, you should not proceed with the contract until all issues have been resolved to your satisfaction. Below are some important points to bear in mind when reviewing a contract.

Key terms and clauses: Every detail in a contract should be scrutinized, but some clauses are more important than others. The most important contract clauses vary by company and industry, but there are some clauses that require special attention in all areas. Confidentiality, indemnity, termination and dispute resolution clauses are all important parts of a contract that are worth investing extra time in reviewing.
Termination and renewal clauses: Before signing a contract, make sure you fully understand the contract's termination and renewal clauses to avoid unwanted renewals or the inability to withdraw from the contract in a timely manner.
Clear, unambiguous language: Pay attention to the wording of every sentence in the contract to avoid ambiguous clauses or clauses that are open to interpretation. It is important to modify the language to minimize potential conflicts, and if there are significant conflicts, third parties may need to determine further steps depending on their interpretation of the contract.
No blanks: Using a contract template is a great way to save time, but be sure to fill in or remove all blanks during the review phase. Not filling in blanks in a contract can lead to problems or disputes later on.
Default clauses: Although both parties usually sign contracts with good intentions, it is important to consider possible defaults. Pay attention to the default clauses in the contract and be aware of the possible consequences of a breach of contract.
Key dates and deadlines: It is important to ensure that all dates and deliverables are consistent with previous assignments and to track the team's progress in completing tasks to minimize the risk of breach of contract.
Fair distribution of risk: Check whether the distribution of risk in the contract is fair and appropriate. If it turns out that one party is taking on too much risk, the contract may need to be renegotiated or amended.
Understand the provisions on remedies: Familiarize yourself with the contractual provisions on recourse and remedies in the event of non-performance. It is important to understand what actions can be taken in the event of a breach of contract and how liability can be minimized or shifted.

Was ist der Zweck einer Vertragsprüfung?

Contract review not only provides legal protection, but also offers valuable insights into a company's financial and operational efficiency. It ensures that contracts not only comply with legal requirements, but are also optimally designed to minimize risks and control costs. The specific objectives of contract review and the added value it offers companies are as follows:

1. Cost management and evaluation

Die Vertragsprüfung trägt zum organisatorischen Kostenmanagement und zur Bewertung der mit den Verträgen verbundenen Ausgaben bei. Durch die Prüfung der Vertragsbedingungen können die spezifischen Kostenstrukturen von Verträgen ermittelt und die Kosteneffizienz der Verträge bewertet werden. Auf diese Weise können Unternehmen ihre Ressourcen besser verwalten und sicherstellen, dass die Vertragsunterzeichnung und -ausführung wirtschaftlich effizient sind.

2. Analysis and assessment of risks

A contract review also aims to analyze and assess the various risks in contracts. Auditors carefully examine contract terms, identify potential legal, commercial and operational risks and assess the extent of the impact of these risks on the company. This helps companies develop risk management strategies to minimize adverse effects and maximize the protection of the company's interests.

3. Extraction and documentation of contract data

Another important purpose of the contract review is the extraction and documentation of key data from contracts. The auditors collect the contract documents and extract key information such as contract terms, deadlines, responsibilities, etc. This data is recorded and organized for later reuse. By effectively managing and documenting contract data, companies can better monitor contract execution and make timely decisions.

Common errors in contract review:

Mistakes often creep in during contract review, which can have far-reaching consequences - from financial losses to legal complications. Many of these mistakes arise from the assumption that reviewing contracts is time-consuming or unnecessary, or that certain terms are non-negotiable. However, it is these misunderstandings and omissions that can lead to companies signing contracts that are not in their best interest. Below are some of the most common contract review mistakes that should be avoided at all costs to prevent long-term risks and unnecessary costs:

The view that reviewing complex contracts line by line is a waste of time and money
Signing contracts without reviewing the terms
Failure to fully complete contract templates
Signing vague or incomprehensible contracts
Assuming that all contracts are non-negotiable and must be signed as is
Unnecessary pushing back of non-critical terms and conditions
Delaying non-critical terms that could jeopardize the deal or lead to high legal fees
Hiring lawyers to review contracts without being aware of the costs in advance

Incorrectly filling out contract templates without a lawyer's reviewJeder dieser Fehler kann dazu führen, dass eine Partei Verträge unterschreibt, die nicht im besten Interesse ihres Unternehmens sind, oder, schlimmer noch, die Unterzeichnung des Vertrags völlig unterminiert.

What alternatives are there to facilitate the contract review?

The manual review of contracts is often time-consuming and error-prone. Modern contract management systems use AI to efficiently manage the entire lifecycle of a contract. A recent McKinsey study shows how successfully AI tools are already helping companies to identify potential in existing contracts.

Contract management solutions with AI can automatically scan, identify and classify documents, extracting important information in the shortest possible time and summarizing it in structured reports. Thanks to powerful search, filter and analysis functions, the management and review of contract documents is made much easier.

Functionality & solution providers for AI contract review

The market for AI-supported contract management solutions is growing, but so far there are only a few providers that offer truly mature and secure functions. The approaches differ considerably in some cases - which is why it is important to take a close look at how mature a solution really is. Not everywhere that says AI on the label also contains real innovation.

PACTA is setting new standards in AI-supported contract review and management. As Europe's leading legal AI for contract review and management, PACTA offers an intelligent platform for the analysis, review and digital processing of contracts and documents.

The AI recognizes critical clauses, potential risks and deviations in a matter of seconds. As a result, you receive precise and error-free results, maintain an overview and can efficiently create, update and digitally sign contracts.

“What is particularly impressive is that the PACTA contract check with AI also recognizes cross-references in the contract and uncovers risks that are not directly visible in the clause itself. The results are consistently very good!” Mark Waditzer, Legal Department Manager at ADA Möbelfabik GmbH

Find out more about AI contract review and risk analysis

Automated contract review and risk analysis in PACTA

But how does that work? Themis, PACTA's specially developed AI, simulates the legal thought process during the contract review and automatically compares your legal target status of the playbooks with the actual status of external documents.

Companies such as Schnellecke Logistics already rely on AI-supported contract review and automate the analysis and management of dozens of contracts every month. Find out more in the case study

Themis Copilot - your virtual legal assistant

But that's not all: the new Themis Copilot is a specialized AI assistant for contractual and legal matters - like ChatGPT, but for law! It analyzes, compares and creates contract content precisely for you and answers legal questions comprehensibly and precisely, whether for lawyers or legal laypersons. PACTA makes law accessible to everyone. Get to know Themis Copilot

The bottom line

In summary, contract review is an essential step to ensure the legality of contracts, mitigate risks and protect the interests of the business. By carefully reviewing contract terms, companies can better manage their costs, assess risks and extract important data to ensure effective contract execution and smooth business operations.