Why Legal Contract Management Is Highly Specialized and Depends A Great Deal on Industry Vertical

October 19, 2023

Legal knowledge

Contracts serve as the foundation of business transactions. They codify mutual obligations, protect interests, and manage risk. However, contract management is not a one-size-fits-all approach. To the trained eye, the intricacies of contracts vary extensively based on the industry in question.

For those who navigate the maze of contract management daily, the disparities between, say, hardware and software contracts are glaringly evident. These distinctions emerge from the very nature of the products, the specific concerns associated with them, and the industry standards.

Hardware contracts, although they may have overarching principles around warranties and specifications, truly manifest their complexities when examined under the lens of specific industries.  Software contracts, on the contrary,  often wrestle with matters related to licensing. Issues like automatic renewals, intellectual property ownership, and stipulations surrounding open-source usage become hot topics. The inherent intangibility of software, the fluidity of its distribution, and the complexities of IP make these areas critical.

The Automotive Industry: A Case Study

The automotive industry provides a compelling illustration of how industry verticals necessitate specialized contract management.

  • Industry-specific Standards: Automotive suppliers are beholden to standards exclusive to the industry. They need to conform to specific benchmarks for quality, inspection procedures, and warranty terms that might not be applicable in other domains.
  • The Stakes of Indemnification and Warranty: Vehicles are intricate machines with the potential to cause significant harm. Consequently, indemnification clauses and warranties in the automotive world carry distinct implications. Any potential failure or mishap can lead to devastating consequences, both in terms of human lives and financial repercussions.
  • Complex Supply Chain Dynamics: The automotive industry is characterized by a multilayered supply chain. A single hiccup at one stage can cascade and amplify as it trickles down, causing significant disruptions. This makes the contract clauses pertaining to delivery delays, component failures, and supply chain responsibilities supremely critical.

The Software Industry: Completely Different Priorities

In the case of software licensing agreements, the points that both parties pay attention differ dramatically from the above case

  • License Type:
  • Perpetual vs. Term: A perpetual license allows the licensee to use the software indefinitely, while a term license is for a specified duration. Disputes can arise over renewals or continued usage after term expiration.

  • Exclusive vs. Non-exclusive: An exclusive license grants exclusive rights to the licensee, often preventing the licensor from licensing the software to others.

  • Source Code Escrow: In some agreements, the software's source code is placed in an escrow account. If the developer goes out of business or fails to maintain the software, the source code is released to the licensee. Disputes can arise over the triggering conditions or the quality and completeness of the escrowed source code.

  • IP Ownership:
  • Pre-existing IP: Often, one party brings to the table pre-existing IP, which might be a software library, a platform, or some other proprietary technology. The agreement must clarify that the pre-existing IP remains the property of the party that brought it in. Disputes can arise if this distinction is not clear, especially if this pre-existing IP becomes integrated or foundational to the project.

  • Ownership of Developed IP: For custom software developments or modifications, it's crucial to define who owns the resulting IP. In many agreements, the developer retains the IP while granting the licensee a broad or exclusive license to use the software. In other cases, especially if the licensee is funding the development, the licensee may demand ownership of the IP.

  • Third-party IP: If the software includes third-party libraries, plugins, or other components, it's essential to disclose this and ensure all third-party IP is appropriately licensed. Disputes can arise if third-party IP is used without proper authorization, potentially leading to infringement issues.

  • Joint Ownership of IP: When both parties collaboratively contribute to the creation of new IP, they might opt for joint ownership. While this sounds equitable, it can lead to complications. For instance, in some jurisdictions, joint ownership might mean either party can exploit the IP without sharing revenues unless otherwise specified.

  • Licensing Back: In situations where one party retains ownership of the co-created IP, they might license it back to the other party. The terms of this license (e.g., exclusivity, duration, territories) can become points of contention.

The AI Perspective

The complexities highlighted above underscore the challenge for legal AI, which is still under development. The different focal points of various types of contracts reflect the different risks and challenges that each industry faces. Automotive companies are responsible for ensuring that their products are safe and reliable, while software companies are responsible for protecting their intellectual property and their users' data. The challenge for legal AI is understanding the ultimate goal of each contract, not just mirroring patterns in contract wording. While platforms like ChatGPT have made strides in understanding and generating human-like text, industry-specific contract drafting remains a specialized domain.

For an AI to draft or negotiate such contracts effectively, it would need access to a vast repository of industry-specific contracts. It would have to understand the subtleties, extract pertinent terms, and continually fine-tune its knowledge. A large language model (LLM) trained on a dataset of software contracts may not be able to understand the nuances of a hardware contract that includes provisions on product safety and liability, and legal AI systems may not be able to keep up with the rapidly changing regulatory landscape in the hardware and software industries. Solely relying on generalized training won't suffice. Reinforcement learning, contextual understanding, and real-world feedback would be paramount.

Thus, when evaluating “one-size-fits-all” legal AI solutions, one should approach with caution. Such a promise, without adequate industry-specific training and sophistication, is bound to yield results that are not only biased but also fall short of the nuanced requirements of specialized contract management. Companies need legal AI solutions that are specifically designed to meet their needs, like tailor-made suits, perfectly fitted to the unique requirements of their industry. They need solutions that are able to identify and assess potential risks, draft and negotiate contracts in a way that mitigates these risks, and track and manage contracts throughout their lifecycle. By using a legal AI solution that is specifically designed for their industries, companies save time and money and produce contracts that achieve their ultimate goals, while minimizing their risk.