Contract audits require high attention to detail and way too much focus. And that’s exactly why in-house legal counsel usually dreads this task.
Auditing contracts can be challenging, especially in organizations that run on manual processes. You may struggle to access siloed documents, be forced to deal with unwilling stakeholders, and need to reference overwhelmingly large volumes of clauses to ensure consistency.
However, for the greater good, this is a necessary evil.
In this guide, you will get full clarity on why you need to master contract auditing, as well as best practices you can leverage to audit contracts more productively.
What is a contract audit?
A contract audit is a detailed inspection of contractual agreements to ensure compliance with federal, organizational, and industry standards while identifying areas of risk and potential for improvement.
Think of it as a comprehensive health check for your contractual agreements. Experienced contract auditors meticulously review contractual terms, assess the performance of all parties, and call attention to any area that needs renegotiation.
By conducting a comprehensive contract audit, businesses can ensure that their contractual agreements meet their intended purpose and minimize risks. This can ultimately lead to a healthier bottom line and more successful outcomes for all parties involved.
Contract audit vs. contract review
It is important not to confuse contract audit with contract review, as the two are essentially different from each other.
While a contract audit is an in-depth and comprehensive probing process that can sometimes be outsourced to experts, a contract review is a less exhaustive, preliminary evaluation usually done internally.
Contract review often happens before a contract is signed after ensuring all parties are on the same page. On the contrary, a contract audit is usually conducted during contract execution to ensure that all parties fulfill their obligations and that any emerging risks are proactively identified and tackled.
Importance of contract audit
“Your job is often explaining legal risk in a digestible way to ensure that the business is aware of what could happen and what the consequences of certain decisions may be. Your business teams may be ok with the risks and decide to move forward. Your job becomes mitigating the risk as best you can and not taking it personally if the business is okay moving forward even with the risks you’ve outlined.”
~ Katayoon Tayebi
Associate General Counsel, FIGS
Accelerating Your Career as In-house Counsel
An effective contract auditing process is the difference between a company with happy customers, productive relationships, and great ROI vs. a company embroiled in so many tussles and struggling with value leakages.
This section explores some of the benefits you may get from maintaining a regular contract audit schedule.
#1 Maintaining legal compliance
Contract audits ensure that contractual agreements align with legal requirements and industry standards. This involves reviewing the terms and conditions of the deal in the context of applicable laws, regulations, or policies. By identifying any potential areas of non-compliance, contract audits help organizations take corrective action to ensure their contracts remain legally binding and enforceable.
#2 Curtailing risks
Contract audits identify potential risk areas, such as non-compliance, inadequate dispute resolution mechanisms, ambiguous terms, and changes in market conditions. This allows organizations to proactively mitigate these risks before they become actual problems.
#3 Saving costs
Contract audits can save costs by identifying and preventing overpayments, billing errors, and other financial discrepancies. They help organizations optimize their contracts through better management practices, renegotiating unfavorable terms, and identifying opportunities for cost savings.
#4 Assessing performance
Contract audits assess the performance of all parties involved in the agreement by ensuring that they meet their obligations and contribute to the deal's success. Auditors may review key performance indicators (KPIs) to evaluate how well each party is meeting their targets and assess whether any delays or issues are impacting the overall success of the agreement.
#5 Detecting fraud
Contract audits can detect fraud by identifying irregularities, inconsistencies, and discrepancies in contracts. Auditors may review financial statements, invoices, and other documents to verify that all transactions are legitimate and accurately recorded.
They may also interview relevant parties to gather additional information and identify suspicious behavior.
Types of Contract Audits
Contract audits come in many forms, depending on the nature of your business, your objectives, and contract requirements.
This section explores the major ones.
#1 Compliance audits
A compliance audit examines the contract provisions, including pricing, deliverables, and timelines, to verify compliance with applicable laws and regulations, identify any deviations or discrepancies, and ensure that both parties are working within the boundaries of established regulatory standards.
#2 Performance audits
A contract performance audit examines the quality and effectiveness of services provided by a contractor or vendor.
The audit assesses the contractor's compliance with contract terms and specifications, evaluates the contractor's performance against established standards, and identifies areas for improvement.
It aims to ensure that the contracted work is completed efficiently, effectively, and in accordance with the agreed-upon terms and conditions.
#3 Financial audits
Financial audits examine the financial aspects of a contract, including the contractor's financial statements, invoices, and payments.
They assess the accuracy and completeness of financial statements and records, verifies the contractor's compliance with financial reporting requirements, and identifies any discrepancies or irregularities.
#4 Contract closeout audits
Contract closeout audits are conducted at the end of a contractual relationship to ensure that all parties have delivered their obligations and that all deliverables have been fulfilled.
The purpose of these audits is to identify any outstanding issues or discrepancies and to ensure that all final payments have been made.
#5 Subcontractor audits
Subcontractor audits are conducted to ensure that subcontractors have complied with the terms of their contract and have delivered the expected level of quality and performance.
These audits verify subcontractor billing, quality control systems, and adherence to project schedules.
#6 Pre-award audits
Pre-award audits are conducted before a contract is awarded to verify that the potential contractor meets all of the requirements outlined in the bidding process.
These audits evaluate the financial capacity, technical expertise, track records, and overall suitability of the contractor to ensure that the selected bidder can fulfill the contract's requirements.
#7 Post-award audits
Post-award audits are thorough examinations conducted after the contract has been awarded to verify that the contractor is fulfilling all the terms and conditions of the agreement.
These audits focus on evaluating the contractor's adherence to the scope of work, project schedule, quality of deliverables, and cost control measures.
#8 Intellectual property audits
A contract intellectual property audit examines a company's contractual agreements to determine the ownership and protection of intellectual property assets, like patents, trademarks, trade secrets, and licenses.
This audit evaluates the identification and classification of intellectual property, the adequacy of contractual provisions, and the effectiveness of measures taken to protect intellectual property.
Best practices to perform contract audits
“Lawyers are trained issue-spotters, the analysis of risk in commercial agreements and the process of minimizing that risk usually falls in the lap of the in-house legal department. Unfortunately, the process of spotting and analyzing risk is rarely black and white.”
~ Sterling Miller
CEO and Senior Counsel, Hilgers Graben PLLC
Ten Things: Minimizing Risks in Commercial Contracts
Contract auditing is a complex process that requires careful planning and execution to achieve the desired outcomes. To get the best results, here are some best practices to consider:
#1 Define your audit objective according to the required outcome
Contract audits are conducted proactively—as a preventive measure—or reactively—in response to an emergent issue. In any case, it is vital to have a clear picture of what the contract auditing process should achieve.
This is because audits are usually time-consuming, and you want to invest your time and resources in actions that lead you to the right outcome. You may want to conduct audits for several reasons, from identifying the cause of financial discrepancies and assessing contractor performance to evaluating enforceability and closing out engagements.
#2 Identify your area of coverage to plan the audit
Having a clear objective has an immediate impact on the scope of the auditing process. You’ll need to define the area(s) your auditing process will cover.
This can be financial, compliance, risk, intellectual property, performance, or renewal.
Identifying your area of coverage will help you understand the boundaries and limits of the contract audit, the methods you’ll employ, and the duration of the entire process.
#3 Involve the relevant stakeholders for complete transparency
Having identified the area of coverage, you'll need to involve the stakeholders relevant to the said area. For instance, if you're to run a financial audit for any form of cost irregularities, it is crucial to get on the same page with the stakeholders of the financial department.
You’ll usually get in touch with the business your organization is in contract with. Ensure there’s complete transparency throughout the process. That way, your auditing exercise will not be flawed.
#4 Store files in a central location for easy and quick access
One of the first things you must do before carrying out any form of contract audit is to keep all relevant files handy.
If you work in an organization where documents are siloed within separate departments, you’ll have a hard time gaining access to the data you need. To save yourself the hassle, organize the files into a central location ahead of time. That way, you can easily access them when you need to.
#5 Take advantage of a Contract Lifecycle Management (CLM) tool
A CLM is a suite of tools that offers everything you need to manage every aspect of your contract lifecycle.
It provides a centralized repository for housing all contract-related information and documents, which you can easily access during audits. This helps you avoid the hassle of searching through various sources of information, such as emails, spreadsheets, and paper documents, to find relevant contract information.
It also offers a comprehensive audit trail that tracks all changes made to the contract, ensuring transparency and accountability.
Furthermore, a CLM automates manual tasks like reviews, compliance checks, and reporting. This cuts down the time and effort needed to conduct audits, allowing you to focus on higher value-added activities, such as identifying risks, improving contract performance, and making strategic recommendations.
Streamlining your contract audits with SpotDraft
Spotdraft is an all-in-one CLM that offers everything you need for managing every aspect of your contract management lifecycle. But how does it make contract auditing more productive?
1. Centralized contract repository: Spotdraft provides a centralized repository for storing and organizing all contract documents. This makes it easy to access and retrieve contracts during the audit process. That way, you can quickly locate contracts, review terms and conditions, and assess compliance.
2. Version control and audit trail: Spotdraft maintains a version history and audit trail for each contract. This allows you to track changes made to contracts over time, including revisions, edits, and approvals. Having a clear audit trail helps you verify the integrity and accuracy of contract documents.
3. Automated alerts and reminders: Spotdraft sends automated alerts and reminders for important contract dates, such as renewal, expiration, or key milestones. You can set these alerts to ensure timely reviews and audits, reducing the risk of missing critical events.
4. Data analytics and insights: Spotdraft offers data analytics capabilities to extract valuable insights from contract data. You can leverage these data to identify patterns, trends, and potential compliance risks. The data-driven approach helps you focus your efforts on high-risk areas and prioritize audit tasks effectively.
5. Integration with business platforms: Spotdraft integrates with e-signature platforms, CRMs, and other systems you already use for your operations. That way, you complete a wide variety of tasks from one intuitive interface. This ensures that you do not have to go through the struggle of shuffling between different tools during auditing processes.
The devil is in the details
Contract audit is a high-stake exercise, requiring top-notch attention to detail and an in-depth understanding of key contracting policies. Any oversight error can have far-reaching consequences for both the organization and the auditor (you).
However, the best practices discussed above will offer you a fair advantage going into your auditing tasks.
SpotDraft makes contract auditing a lot easier for forward-thinking legal counsel, helping them maintain a high-quality catalog of brand-safe, compliant, and rewarding contracts.
Want to see how that works? Feel free to request a demo with SpotDraft below.