Over the past several years, I have been spending a great deal of time reading sophisticated financial contracts, mostly in the venture capital arena. More than once I have asked myself, "What makes a well-drafted contract?"
- Internal consistency? This is a modest aspiration, but if you don't live in the world of contracts, you might be surprised to learn how often it doesn't happen.
- Accuracy in memorializing the agreement of the parties? Perhaps, though most (all?) sophisticated financial contracts must be much more than that since these contracts contain many terms never discussed by the parties.
- Effectiveness in guiding future actions of the parties without generating disputes over the meaning of the contract? This would be a significant accomplishment, I suppose, even though we know that contracting parties often make midstream adjustments to their relationship. Implicit in this standard is the idea that a well-drafted contract could be interpreted by an independent third party (i.e., a judge) to discover the terms of the bargain.
In his classic article, Value Creation By Business Lawyers: Legal Skills And Asset Pricing, 94 Yale L.J. 239 (1984), Ron Gilson suggests a more ambitious standard: a well-drafted contract economizes transaction costs. In Ron's words: "the tie between legal skills and transaction value is the business lawyer's ability to create a transactional structure which reduces transaction costs and therefore results in more accurate asset pricing."
If you were reading closely, you may have noticed that Ron connects legal skills with transaction value, thus raising the obvious question: why are legal skills required to perform "transaction cost engineering"? Ron has an answer:
The critical importance of transactional structure for purpose of regulation provides the core of an explanation for lawyers' domination of the role of transaction cost engineer. Because the lawyer must play an important role in designing the structure of the transaction in order to assure the desired regulatory treatment, economies of scope should cause the nonregulatory aspects of transactional structuring to gravitate to the lawyer as well. Knowledge of alternative transactional forms and skill as translating the desired form into appropriate documents are as central to engineering transactions for the purpose of reducing transaction costs as for the purpose of reducing regulatory costs; indeed, if these purposes is one or another way conflict, facility at both tasks should result in more optimal trade-offs between them. Viewing the matter from this perspective, it would have been surprising if lawyers had not dominated the field.
This is very clever, and I think it also has the virtue of being right. Which leads me to Usha's post from last week in which she despaired of being "lost in a casebook world." In 1984, Ron asked, "why have law schools done so bad a job in training business lawyers?" His answer was that the absence of a theory of private ordering made classroom instruction no more valuable than apprenticeship. The advent of transaction cost economics, however, emboldened Ron to "present a fairly optimistic picture of the future of this component of the legal academy and profession."
Has that promise been fulfilled? My sense is that things have changed significantly since 1984, partly due to Ron's and Victor Goldberg's initiative in starting the Deals course at Columbia, a version of which Vic still teaches. That course (which was discussed at a AALS conference on transactional law held during my second year of teaching) inspired much of my experimentation with teaching transactions, and I know that many other law professors are also teaching transactional courses and introducing transactions into mainstream courses. The proliferation of business law clinics is also a happy development.
Yet, I believe we have some distance to travel before we obtain Ron's aspiration for the training of business lawyers. The vast majority of law students still graduate without significant transactional training. Standards for "best practices" in transactional training do not exist, and as a result, training opportunities vary widely, from heavily theoretical to almost exclusively practical. Finally, materials are mostly homemade, thus requiring a significant investment of additional time to teach such a course.
Where do we go from here? I would be very interested to hear thoughts about next steps. Not just baby steps, like using HBS case studies in Bizorgs, but big steps. How do we take transactional training to the masses?
Oh, and if you would be interested in helping me to organize another AALS conference on transactional law, let me know. It's overdue.
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1. Posted by Jeff Lipshaw on October 19, 2006 @ 5:48 | Permalink
Count me in.
2. Posted by Tom Joo on October 19, 2006 @ 11:31 | Permalink
I think (hope) pedagogy has picked up on the value of teaching law from a transactional _perspective_, even if we have a lot further to go in directly teaching transactional _skills_. Although most corps books are still casebooks, many (eg O'Kelley & Thompson) have very useful problems encouraging the student to structure a transaction "in the shadow of the law." After teaching a case, I often ask the students what the parties (or their lawyers) could have done better in structuring or governing the BA (esp. in closely held forms where contract plays a greater role), or what they should do differently next time in light of the case. I think this is what Gilson is talking about: why (good) lawyers ought to make good transaction cost engineers.
I'd be interested in pitching in on a conference--Although I don't teach any formally "transactional" courses, how about a panel on this--call it "transaction-lite" teaching?
3. Posted by Lisa Fairfax on October 19, 2006 @ 13:38 | Permalink
Gordon, I am in the middle of teaching a course right now called "corporate transactions" where we go through the documents of a mock corporate transaction--in this case a stock acquisition. I start with a letter of intent, go through various provisions of a purchase agreement, then end with an opinion and closing certificates. Having just reviewed all of the reps and warranties assignments, I can confirm that this is a daunting process. Not just because students are unfamiliar with the format, issues and concepts, but also because if you want to do it right, it takes a lot of energy to respond to the 20 ways students approach marking up a document for the first time.
As you point out, one of the big issues in this area relates to finding the right materials and thinking about the right structure for the course. Another is to try and figure out what to expect from students in this area, and to try to get them to adapt to a different set of expectations.
I think taking transactional training to the masses requires much more coordination about both materials and methodology.
I also think it is probably the case that we have not traveled as far as we'd like to think. It is my sense that, to the extent there is more transactional lawyering occuring in law schools, it is not by full time faculty. Instead, what you tend to find in law schools is that full time faculty may dip a bit into issues surrounding transactional work, but adjuncts do the heavy lifting with document drafting courses. This is not a criticism, but just a recognition that such classes require different efforts, time and skill than more traditional ones. And maybe are best left in the hands of the "experts." Indeed, I do not teach this course every year because it is a huge time commitment in a way different from my other courses. But if we appreciate that reality, the other thing we need to do is bring the relevant faculties together on this. That is, we need to think about a course packaging that allows the full time and adjunct faculty to interact more comprehensively. Maybe something that introduces students to this stuff in phases from light to intense. It is something about which I have been giving considerable thought.
So definitely count me in to this discussion.
4. Posted by Usha Rodrigues on October 19, 2006 @ 17:58 | Permalink
A provocative post, Gordon. I’ve been thinking a lot about the concept of “stickiness” and law teaching: what parts of students' classroom experience will they be thankful for in 5 years? 10?
I agree that the classroom experience should be more than mere apprenticeship, but students need to know skills like how to make an agreement internally consistent, for example, as well as a larger sense of deal structure and where lawyers can add value in strategizing with clients. No answers here, unfortunately, just questions. I’m in, as well.
5. Posted by Jake on October 20, 2006 @ 21:13 | Permalink
A well-drafted contract is one that withstands the attempted introduction of parol evidence when it is challenged in court.
6. Posted by Jeff Lipshaw on October 21, 2006 @ 11:51 | Permalink
That's a Willistonian view of the world.
What if that contract withstands the introduction of parol evidence but doesn't reflect your client's view of the deal because of terms that in retrospect are ambiguous when applied to the present circumstance?
And how do you deal with evidence that is parol but not offered to vary or contradict the terms, but to explain the context of the deal (i.e. why your client's interpretation of the terms is correct?)
What if the present circumstance was something that the parties simply did not or could not predict?
What if the only way the deal could get done was by agreeing on a term the parties knew was ambiguous?
7. Posted by Jake on October 21, 2006 @ 23:28 | Permalink
Responding seriatim to Jeff's points:
(1) "That's a Willistonian view of the world."
(2) "What if that contract withstands the introduction of parol evidence but doesn't reflect your client's view of the deal because of terms that in retrospect are ambiguous when applied to the present circumstance?"
The phrasing of this query is difficult to tackle (my fault probably, not Jeff's), but the answer likely hinges on whether the client stands to gain or lose from contractual ambiguity.
(3) "And how do you deal with evidence that is parol but not offered to vary or contradict the terms, but to explain the context of the deal (i.e. why your client's interpretation of the terms is correct?)"
In terms of litigation dynamics, there's really nothing to "deal with" here. If, as the question presupposes, my client's interpretation of the contract terms is correct, I'm certainly not going to oppose the introduction of parol evidence going the same way.
(4) "What if the present circumstance was something that the parties simply did not or could not predict?"
The law of contractual mistake, impossibility of performance, or commercial impracticability, deals quite handily with this point.
(5) "What if the only way the deal could get done was by agreeing on a term the parties knew was ambiguous?"
In that event, the parties should include an ironclad ADR clause in the contract.
8. Posted by JMWjr on October 22, 2006 @ 18:23 | Permalink
"Value creation by business lawyers" won't happen until:
1. Business lawyers are required to have a better business education. Most simply are able to mimic business terminology that they hear from their clients- if asked to explain what they just said in using business terminology, lawyers can't do it. At a minimum, business lawyers ought to be taught how to measure the estimated financial impact of the advice they give to businesses.
2. Law firms quit expecting clients to be accountable for the remarkably poor economic decisions that law firms annually make regarding the compensation paid to young lawyers. The training of young lawyers should be treated as an overhead expense - as is the training cost of unexperienced personnel in other businesses - and not be billed to clients as if some magical value has been created for the client by the young lawyer. Billing clients for young lawyers' time is as big a sham as is the manner in which "billable time" is billed to clients - and dissipates real transaction business value.
3. All lawyer egos in a transaction are checked at the door. Lawyer egos are a great "dissapater" of transaction value.
4. Someone creates a law firm that is something more than a collection of sole proprietorships that share expenses.
5. Lawyers understand the difference between "practicing law" and "the business of practicing law" and place someone who truly understands the latter in charge of law firm operations.
Unfortunately, based on my 30-years' experience in the arena - which has led me to conclude that hell will freeze over before any law firm adopts and puts into practice a single one of the above actions - I hold out no hope for value creation by business lawyers.
9. Posted by save_the_rustbelt on October 23, 2006 @ 9:28 | Permalink
It would be an improvement if lawyers studied enough accounting to use financial terms accurately (e.g., using income when they mean revenue).
Would make life easier come litigation time.
10. Posted by Steve Champlin on November 6, 2006 @ 13:57 | Permalink
I think you hit the nail on the head. Keep up the good work!