- Suboptimal contract terms and conditions combined with a lack of effective contract management means that businesses employing them lose money.
- Technological innovation has accelerated at an exponential pace, ushering in an era of unprecedented advancements in algorithms and AI technologies to which lawyers must adapt.
- This means lawyers must look at contracts in a new way and bring into the fold new AI systems that automate contract review tasks to keep the businesses they represent competitive.
Andrew Pery and Michael Simon have been commissioned by the ABA Business Law Section to write a book on Contract Analytics adoption trends. To that end, they have asked the Business Law Section membership to complete a brief survey about your views and use of Contract Analytics technology. You can access the survey by clicking here.
In his seminal work On Legal AI, Joshua Walker, a pioneer in the application of AI to the practice of law, posited the following rhetorical question relating to the benefits of applying AI to contract analysis: How do we use AI to produce “wise contracts”?
Walker’s predicate for posing this question is based on compelling empirical evidence. The legal profession is using outdated and inefficient practices in contract formation and analysis. As lawyers, we tend to be creatures of habit and, as Walker warns, “include certain vestigial clauses whose original purpose has long been absent and . . . do not necessarily reflect evolving business realities.”
In today’s interdependent and high-velocity business climate, contracts should not be viewed only as legal documents that may be used both as a sword and a shield in the event of breach or noncompliance, but rather as documents that set out a mutually enduring business relationship between the contracting parties. This ambition is far from current practices, however. In a recently published HBR article, A New Approach to Contracts, the authors, David Frydlinger, Oliver Hart, and Kate Vitasek, found that:
“[w]hen contract negotiations begin, they default to an adversarial mindset and a transactional contracting approach . . . used to try to gain the upper hand. However, these tactics not only confer a false sense of security but also foster negative behaviors that undermine the relationship and the contract itself.”
A McKinsey study likewise found that a narrowly focused transactional approach to contracting leads to considerable inefficiencies because such contracts “are lacking basic elements that could enable better vendor performance and cost savings.” Contracts are the engine of a business, with 90 percent of spending and investments governed by terms and conditions embodied in them, yet the McKinsey study found that “suboptimal contract terms and conditions combined with a lack of effective contract management can cause an erosion of value in sourcing equal to 9 percent of annual revenues. For Fortune’s 2016 Global 500 companies, this 9 percent would have equaled $2.5 trillion in value.”
Among the recommendations proposed by the McKinsey study is implementation of more rigorous contract review processes that involve cross-functional collaboration between operations and legal teams in order to achieve “greater visibility into existing contracts to enable the organization to write better contracts going forward. A semiautomated, basic screening process involves scanning contracts for keywords and phrases related to performance, value, and selected cost drivers.”
In the case of investigational contract analytics, contract language is important to surface obligations, potential liabilities, choice of law and forum, and representations and warranties in the event of material breach and penalties. Andrew Bartels, a contract life-cycle expert at the industry analyst giant Forrester, refers to this aspect of contract analytics as “who is responsible or liable when things don’t work as planned.”
According to the Institute for Supply Management, a typical Fortune 1000 company manages anywhere between 20,000 to 40,000 active contracts at any given time, at least 10 percent of which are misplaced, difficult to find, still in paper form, or on a file share somewhere, buried in an e-mail attachment, or otherwise unmanaged or forgotten. Unsurprisingly, the general counsel respondents to a Lexis 2018 study demonstrated that more than half of them—53 percent—spent “too much time on repetitive tasks.”
The pressure to adapt to the demands of high-velocity business transactions coupled with an intensely competitive global business environment is transforming how legal services are consumed and delivered. Richard Susskind, in his book Tomorrow’s Lawyers, referenced a confluence of three market drivers that impact the practice of law:
- The “more for less challenge.” While legal department’s budgets are cut, the demand for increased output is increasing whereby legal departments are “facing the prospect of an increasing workload and yet diminishing legal resources.”
- Liberalization of legal services delivery. Several jurisdictions now endorse Alternative Legal Service Providers (ALSPs), which could pose a significant competitive threat to traditional law firms. The ALSP market is pegged at $11 billion.
- Legal expert systems. New AI systems mimic (even if they cannot replicate) human cognitive intelligence and automate tedious and labor-intensive contract review tasks traditionally performed by an army of over-worked lawyers. By way of illustration, JP Morgan developed an automated commercial credit and contracts review AI-based application that can extract 150 attributes from 12,000 commercial credit agreements and contracts in only a few seconds with a high degree of precision—the equivalent to 360,000 billable hours of legal work by its lawyers.
The level of innovation and its transformative impact on the practice of law is unprecedented. As a recent Yale Journal of Legal Technology article warned: “Technological innovation has accelerated at an exponential pace ushering in an era of unprecedented advancements in algorithms and artificial intelligence technologies . . . . [T]o survive the rise of technology in the legal field, lawyers will need to adapt to a new practice of law.”
Looping back to Joshua Walker’s question—“how do we use AI to produce wise contracts?”—the application of AI to contract formation and analysis is not a panacea. Contrary to the dystopian view that AI will replace lawyers, its likely impact will be as a compliment to good and efficient lawyering. One thing is certain, however: as Joshua Walker observes, “AI is fast. AI is cheap and you [as lawyers] are neither.”
Andrew Pery and Michael Simon have been commissioned by the ABA Business Law Section to write a book on contract analytics adoption trends. Please complete a brief survey about your views and use of contract analytics technology. The survey will take less than 20 minutes to complete. Please don’t miss your chance to tell us how you see the future of contracting.