NEW REPORT: The State of CLM and AI-Powered Contract Intelligence

Contract Intelligence and Rise of Large Language Models in Contract Management

June 5, 2024 By Shibhu Nambiar, Senior Director, Product Management, Icertis

A Contract Is Trust, Transcribed

Contracts are far more than simply a collection of legal protections; they are intricate instruments representing business, partnerships, trusts, and bonds. This complex and multifaceted idea—the idea of the contract--has a rich history, and its evolution reflects shifts in societal values, economic models, political structures, and changes in regulations and human connections. Much like money, which Naill Ferguson, in “The Ascent of Money,” describes as “trust inscribed”, a contract embodies the trust and mutual understanding between parties, underpinning the very fabric of commerce and cooperation in human society.

Historical Perspective

Around 3100 BCE, the Sumerians, who inhabited ancient Mesopotamia, developed one of the first known systems of writing. They used it to document a range of economic and legal transactions, from the sale of goods and property to marriage and employment contracts. These contracts often included witness signatures and were sealed with the marks of the parties involved, indicating their consent.

As societies became more complex, the need for a systematic way to record and enforce agreements became evident. Roman law, particularly as it pertains to contracts, was highly advanced and served as a foundation for much of Western legal thought, including contemporary contract law. Romans recognized several types of contracts including verbal contracts (verborum obligatio), written contract (litteris), real contract (Re), and consensus contracts (consensu). The legal innovations such as the concept of consent, contractual capacity, enforcement & remedies, and good faith (bona fides) are attributed to Romans. Over time, as societies evolved, so did the nature and scope of contracts, influencing and reflecting the economic and social dynamics of the times.

Economic Perspective

To stimulate investment, trade, and smooth operation—and, in turn, enable commercial markets to flourish—a certain level of predictability is crucial. Contracts, serving as the backbone that allows for the clear specification of transaction terms, thereby mitigating uncertainties, provide such predictability. By providing a legal framework that supports everything from simple sales agreements to sophisticated financial arrangements, contracts underpin critical economic concepts such as property rights, employment relationships, and commerce. Contracts facilitate the growth of trade from localized markets to an intricate global economy, highlighting the indispensable role of contracts in apportioning resources and managing risks in a predictable, legally enforceable manner.

Political Perspective

Contracts form the foundation of a state’s governance and its relationship with its citizens. Philosophers such as Jean-Jacques Rousseau, in the social contract theory, articulates that the state derives its legitimacy from a contractual agreement with its citizens, in which individuals consent to sacrifice certain freedoms in return for the state's protection of their rights and maintenance of order. International treaties play an essential role in fostering global peace, alliances, and trade, further underscoring their significance in the modern political ecosystem.

Cultural Perspective

The significant variation in how contracts are negotiated, interpreted, and enforced across different cultures reveals that contracts reflect and influence societal norms, values, and practices. While some cultures focus on the exact terms and conditions, valuing clarity, and predictability, others prioritize the relational aspects of contracts, emphasizing trust and the relationships between parties. The significance of oral contracts in certain communities stresses the importance of honor and social bonds in upholding agreements. In contrast, other societies place a higher emphasis on written documentation and legal processes, reflecting differing cultural values around trust, honor, and the role of the state in agreement enforcement. This diversity illustrates how contracts are intertwined with cultural expectations and practices, highlighting the balance among individual honor, community trust, and legal formalities.

From Analog to Digital: Contracts as the Foundation of Commerce

In the late 20th century, enterprise resource planning systems (ERPs) emerged as powerful systems, automating business processes and integrating various organizational functions, thus improving efficiency. These systems transformed how businesses managed their internal processes, from recruitment and payroll to inventory management and financial reporting. Although businesses began to embrace the digital revolution, and many facets of business operations underwent significant changes, contracts— the fundamental agreements that underpin every commercial transaction and partnership—were slow to evolve from the analog to the digital world. 

Challenges With Manual, Paper-Based ContractManagement

Legal departments were laggards in the digital transformation journey. Contracts continued to be drafted, signed, and managed manually, involving physical paperwork, which was not only time-consuming but also prone to errors. The persistence of manual, paper-based contract processes stood in stark contrast to the automation and digitization transforming other areas of business operations. 

Despite these challenges, contracts' intrinsic value and necessity in facilitating commerce and managing relationships remained undisputed. Their role in delineating the responsibilities and expectations of each party made them indispensable in the commercial landscape.

Contracts Govern Complex Business Rules Today–Intelligent Systems Needed

With the evolution of contracts from simple agreements to sophisticated instruments that govern complex arrangements such as intellectual property rights, data protection, environmental regulations, global jurisdictions, regulatory standards, and financial incentives, modern and fast-paced organizations are realizing the importance of intelligent contract management systems.

Moreover, the digital revolution has broadened the scope and diversity of contracts, making adept contract management not only a tool for ensuring compliance and minimizing risks but also a significant competitive advantage that strengthens business relationships across geographies and cultures.

Memorialization: What’s In a Contract

Contracts provide a structured outline to define the terms of engagement between parties. Understanding the anatomy of a contract is vital to navigating the complexities of commercial relationships and ensuring mutual benefit. This becomes essential given that 29% of an organization plays a role in contract management per World Commerce and Contracting Benchmark Report(2023).

At its core, a contract is composed of several key components that outline the specifics of the agreement:

Parties Involved:

Identifies the entities (individuals or organizations) entering the contract.

Commercial Terms:

Specifies the terms of the business arrangement, including the scope of work or products and services to be delivered.

Legal Clauses:

It encompasses the legal terms and conditions that govern the contract, including jurisdiction, dispute resolution mechanisms, and confidentiality agreements.

Obligations:

Details of what each party is obliged to do under the terms of the contract, including service levels, deliverables, and timelines. This includes financial, regulatory, and societal obligations.

Service Level Agreements (SLAs):

Defines the level of service expected from the provider, including availability, response times, and performance criteria. Dive deeper into the benefits of SLA and its uses in this article here.

Products and Services:

Describes the specific products or services being exchanged, including specifications and standards.

Pricing and Discounts:

Outlines the financial terms, including pricing structures, payment schedules, and any discounts or incentives.

For a detailed discussion of contractual obligations and their importance, see this article here.

Role of Large Language Models in Contracts

With exceptional abilities to accurately parse and extract data elements from unstructured data and subsequently interpret them, large language models (LLMs) are revolutionizing the conventional labor-intensive contracting process, thus enabling efficient memorialization of the intent of contracts. LLMs are extraordinary in categorizing the vast and varied language found in contracts, which enables them to navigate the nuances of legal language, extract pertinent details, and structure them in a format that is both accessible and actionable. This capability is invaluable in memorializing the intent of a contract, as it ensures that the clauses, commercial terms, and obligations are accurately captured and represented in a form that aligns with the data architecture of ERP systems.

Contract Operationalization: Connected Experiences

A contract's true business and economic value lies not in its memorialization but in its operationalization—the process of translating contractual agreements into tangible business actions and outcomes, thus enabling compliance and value realization. The structured data derived from contracts through LLMs becomes a linchpin in operationalizing these agreements within an organization's operational ecosystem. By facilitating the seamless integration of contract data with ERP systems, LLMs enable a level of synchronization that was previously unattainable. Such connectivity allows for the automatic enforcement of negotiated contract terms during the execution of the various business processes, from sourcing and procurement to sales and billing.

Buy-Side Contracts

For instance, in a buy-side contract, operationalization involves ensuring that pricing and discounts are enforced in procurement systems. This means that purchase orders issued to suppliers reflect the negotiated prices and invoices from suppliers are validated against the contractual terms. 

Sell-Side Contracts

Similarly, the lead-to-cash systems ensure that sales activities, pricing, and revenue recognition adhere to the agreed terms for sell-side contracts. Achieving this level of integration and operationalization is only possible when the contract management system is seamlessly connected with various operational systems, such as source-to-pay processing systems for buy-side and lead-to-cash for sell-side contracts. This connected experience ensures that contracts are not just documents stored in a digital repository but are living entities that drive and govern business transactions.

“Organizations continue to experience 8.6% contract value erosion due to ‘weakness in the contracting process’” – World Commerce & Contracting, Benchmark Report, 2023

Value of LLM-ProcessedData in Contract Processes

Per the World Commerce and Contracting Benchmark Report (2023), a typical organization has contract data stored in 24 different systems . The operationalization of contracts, powered by integrating LLM-processed data into ERP systems, brings about transformative benefits to organizations. Firstly, it significantly reduces the risk of compliance breaches by automating the enforcement of contractual terms across business operations. Secondly, it improves the efficiency of contract management processes, drastically reducing the need for manual data entry and verification. Moreover, this integration provides real-time visibility into contract performance, enabling businesses to monitor adherence to SLAs, track the fulfillment of obligations, and respond proactively to potential issues.

Realizing the Spirit and Intent of a contract

Far beyond their legal implications, contracts hold the potential to forge strong bonds of trust and mutual respect, laying the foundation for enduring partnerships. Contracts, in essence, are a manifestation of the spirit and intent behind business engagements. They codify the mutual aspirations of the parties, aiming not only for legal conformity but also for the realization of shared goals. The trust and longevity of business relationships can be greatly enhanced when contracts are crafted with fairness and transparency. Contracts that clearly articulate the expectations, accountabilities, and rewards for all parties can transform a transactional encounter into a collaborative partnership.

Organizations engage in contractual relationships to execute the intent of the contract, and contracts designed to be executed with a high degree of performance inherently possess qualities such as clarity, achievability, and balance. These traits incentivize all parties to not only be accountable for their obligations but also to fully equip themselves for success. Moreover, when contracts are fair, transparent, and executable, they significantly reduce the likelihood of disputes. Disagreements often arise from misinterpretations, unmet expectations, or perceived injustices within the contractual terms. Fair and transparent contracts set a precedent, encouraging a culture of integrity and respect across the industry. They serve as beacons guiding businesses towards practices prioritizing mutual success over zero-sum gains.

You may also like: Adapting the RICE framework for contract management

Types of Contracting Technology and How to Evaluate Them

Over the past two decades, Independent Software Vendors (ISVs) focusing on automating contract management processes have developed along two primary tracks, each with its distinct approach and target audience.

Pure Play Contract Management ISVs

These vendors specialize in contract authoring and workflow automation explicitly tailored for the contracting process. In this category, companies are often split into those focusing on sell-side contracts and those on buy-side contracts. Sell-side focused companies typically build applications that integrate with popular customer relationship management (CRM) systems like Salesforce, targeting General Counsels (GCs) and Chief Revenue Officers (CROs). Conversely, buy-side focused vendors cater to GCs and procurement departments, integrating with procurement applications to enhance operational efficiency. Vendors that attempt to bridge both sell-side and buy-side often excel in providing robust capabilities for legal professionals but often struggle to achieve deep integration with operational systems.

ERP and operational Systems

These systems incorporate contracting models that facilitate the execution of contracts within the context of specific business processes, such as billing and procurement. The primary buyers of these systems are IT departments, which has historically led to a gap in creating comprehensive tools that cater fully to the needs of legal professionals.

Ever-evolving business models, complex regulatory environments, global supply chains, and recent technological advancements are resulting in the rise of contract intelligence applications in the market. Today, enterprises face the challenge of selecting a Contract Lifecycle Management (CLM) application that not only meets their current needs but also anticipates and adapts to future requirements. 

A "future-proof" CLM SaaS application is essential, but determining what qualifies as future-proof can be complex. Here, we expand on key frameworks that enterprises should consider while making technology investments.

Axiom 1: Flexibility and Extensibility

The diversity of contract types and requirements across different industries is vast, with variations often buried deep within each type's unique definitions and properties. A future-proof CLM system must offer exceptional flexibility and extensibility. This means going beyond basic systems that allow the addition of a dozen attributes to enable the incorporation of hundreds of attributes as core capabilities.

Moreover, such systems should support comprehensive frameworks for template and clause selection, underpinned by robust rules engines. They should also include flexible human workflow management capabilities for review, approval, and signature processes. The most effective systems enhance these features with an extensible and intuitive user interface that encourages organizational adoption and facilitates self-service capabilities. This allows enterprises to adapt dynamically to changing business conditions by modifying rules and processes on demand.

Axiom 2: Business Intelligence

The predominance of unstructured data in the contracting space has traditionally posed significant challenges in terms of data analysis and actionable insights. However, the advent of generative AI is revolutionizing the ability to extract actionable insights, bringing them directly to the forefront of user interaction. Such technologies are offering capabilities that extend far beyond traditional automated tasks, such as the creation of contract drafts by generating comprehensive documents by coupling learned data with predefined templates, thus reducing the time and effort involved; identifying potential risks and liabilities within contracts, alerting managers to issues that require attention before they escalate; and suggesting the most advantageous contract terms by analyzing historical data and current market conditions during contract negotiations.

Leveraging Generative AI a CLM Solution

Per the Law Department Operations Survey, 2023, more than 85% of legal operations professionals believe they’ll be using AI in the next three years. Enterprises seeking to leverage GenAI in CLM should consider several key factors when selecting an independent software vendor (ISV).

1. Richness of Data Sets

The choice of ISV should be based on the richness of their data sets, as more comprehensive data allows for more accurate analyses and insights. 

2. Advanced Visualization Tools

ISVs that offer advanced, intuitive visualization tools enable users to interact with and understand complex data more effectively, facilitating better decision-making.

3. Continuous Investment in Cutting-Edge AI

Finally, enterprises should prioritize ISVs that continuously invest in cutting-edge AI technologies and possess the expertise to seamlessly integrate these advancements into their solutions. Such vendors are likely to lead in the CLM market, providing robust, innovative systems that are adaptable and forward-looking, ensuring long-term efficiency and compliance for businesses.

Axiom 3: Connected Experiences

Legal departments have traditionally been slow in adopting new technologies. To accommodate this, almost every ISV has developed some form of plugin to work seamlessly with Microsoft Word, the preferred tool for many legal professionals. Contracting processes cannot effectively operate in isolation. For example, in sell-side scenarios, contracting is closely linked with upstream processes like opportunity and quotation management and downstream processes such as ordering delivery and revenue recognition. Similarly, on the buy-side, contracting interacts with processes from end-user requests to sourcing, procurement, receipt, and invoicing.

Rise of Generative AI and LLMs in Contract Management

The rise of generative AI technology and large language models (LLMs) are revolutionizing CLM in several critical ways.

1. Building Clause and Template Library

Generative AI enhances the efficiency of constructing clause libraries by analyzing and parsing data from existing contracts. This technology can identify frequently used clauses and patterns within legacy contracts, allowing for the creation of a comprehensive clause library. Once individual clauses are identified, GenAI can automate the development of an optimal assortment of legal templates. This initial step streamlines the preparation stage, ensuring that legal teams have immediate access to standardized and compliant legal language.

2. Contract Authoring

Large language models are particularly adept at drafting initial versions of the contracts and defining the scope of work. By accessing a vast corpus of prior contracts, LLMs leverage their advanced natural language understanding and contextual awareness to not only speed up the drafting process but also enhance the accuracy and relevance of the contract content, leading to faster and more efficient contract negotiations.

3. ContractReview and Redlining

During the review phase, LLMs can process and interpret complex contractual language and compare it against the original versions shared with suppliers or partners. They can quickly assess changes, identify critical differences, and summarize these modifications for better readability and understanding. Additionally, LLMs can assist in translating contracts into various languages, providing initial drafts swiftly. Acting as co-pilots, these models empower legal departments to conduct more thorough and expedited reviews.

4. Risk Assessment

LLMs can leverage historical data to identify patterns and predict potential contractual risks. For instance, they can access a repository of corporate lawsuits to pinpoint clauses potentially leading to disputes. By proactively recognizing these risks, organizations can address potential issues before finalizing the contract, thereby mitigating future legal challenges and enhancing contractual compliance.

5. Post-Execution Monitoring

Post-contract execution, LLMs continue to play a vital role by monitoring existing agreements against evolving regulations and suggesting necessary updates. Secondly, traditional ERPs employ simplistic invoice matching rules (2-way and 3-way) to validate invoices against contracts. However, LLMs can play an expansive role in enforcing the negotiated commercial terms at the time of invoice processing.

6. Connecting to Other Systems

It is crucial for enterprises to select a CLM SaaS application that not only offers seamless out-of-the-box experiences with common business applications such as sales automation, CPQ, sourcing, and procurement but also provides robust capabilities for integrating with these other systems in their ecosystem. Such integration should facilitate the orchestration of end-to-end business processes, enhancing the operational flow and not merely focusing on data interchange. This ensures that the CLM system enhances productivity and compliance across all stages of the contract lifecycle.

Choosing the right CLM technology requires a strategic approach that looks beyond immediate needs to consider long-term adaptability and integration. By prioritizing flexibility and extensibility, leveraging advanced business intelligence, and ensuring connected experiences across business processes, enterprises can invest in a CLM system that is truly future-proof. Such a system will not only support current operational needs but also adapt to evolving business strategies and technologies, ensuring sustained value and competitiveness in a rapidly changing business environment.

Conclusion

In conclusion, the transformation from analog to digital contract management marks a significant evolution in the foundation of commerce, driven by technological advancements and the increasing complexity of global business interactions. As contracts evolve from simple paper-based documents to complex digital agreements, they continue to underpin every commercial transaction and relationship, reflecting the shift towards a more interconnected and automated business environment.

The advent of large language models and other AI technologies in the contract management domain represents a paradigm shift. These technologies can process and analyze vast amounts of unstructured data, enabling more informed decision-making. These technologies foster a deeper understanding of the legal nuances and help memorialize the intent of contracts more accurately, ensuring that the spirit and letter of agreement are fully realized in their execution.

As businesses continue to navigate the complexities of a digital economy, the role of technology in contract management becomes increasingly critical. Enterprises must choose their Contract Lifecycle Management (CLM) systems wisely, considering the current capabilities and future adaptability. ISVs that prioritize flexibility, integration, and advanced analytics and offer connected, intuitive experiences will lead the market. Investing in such future-proof technologies ensures that organizations can keep pace with the rapid changes in commerce, regulation, and technology, thus maintaining their competitive edge in a digital-first world.

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