Teaching Assistants: Choi, Gulati, and Scott on Contract Hazards
Mitu Gulati (below) was kind enough to share with me the manuscript of his new book, co-authored with Stephen Choi (farther below) and Robert Scott (farthest below), Contract Hazards: Lawyers and their Landmines. We have previewed the book here and discussed the book’s themes here before, most recently here. Now the book is out, and it’s really interesting.
The book is like no other contracts book I’ve read before. In part, that is because I have never been interested in sovereign debt, which is the subject of the first portion of the book and the kind of contracts that inspired the Authors to investigate the problem of contractual landmines. Their “picaresque” tale also explores M&A transactions and syndicated leveraged loans. That’s not sweetening the deal for someone like me who struggles to understand his credit card bill. None of that detracted from my enjoyment of the book, which looks at really complex transactions from a sociological perspective. You have to understand doctrine and contract design in order to spot a landmine, but you need a sociological perspective to tell you how they arise and why they persist.
A landmine is a seemingly innocuous provision buried within a complex transaction negotiated by transactional lawyers from top global law firms. One would think that the diligence and sophistication of the attorneys who generate such contracts would either prevent landmines from arising or lead to their quick discovery. So, the Authors’ first arresting discovery is that landmines exist — according to sovereign debt guru Lee Buchheit, there are “a handful” of landmines in each contract. But the book’s real revelation is that the landmines persist, and it may be impossible to eliminate them.
Their work constitutes a strong intervention into a scholarly debate about contract design. In work that we have written about extensively (for example here), some scholars point out that courts often impose default contracts remedies when the parties have carefully negotiated a specialized allocation of risk. That scholarship scolds courts for ignoring the parties’ intentions and for ignorance of the commercial context in which transactions arise. The Authors suggest that there may be times when courts ought to impose default remedies, because the parties, despite their sophistication, actually have not thought through all of the consequences of their contractual allocations of risk. And of course, both may have part of the story right. That is, there are times when the parties depart from common-law defaults intentionally, and there the courts ought to defer to the parties’ intentions. At other times, the departure from standard risk allocation is a product of a landmine. In such cases, perhaps courts ought to look beyond the text to the parties actual intentions. If such intentions cannot be determined, imposing default rules may provide some guidance.
After discovering landmines in sovereign debt instruments, the Authors grew curious about whether they exist in other complex agreements. Sure enough, they soon learned of landmines in M&A agreements.
Landmines exist for a variety of reasons. The Authors introduce a variety of theoretical constructs that help explain the how landmines arise and perist: “market” contracts as “artifacts,” “subversive accretions,” often by attorneys employed by sovereigns, the divided market in agency costs, satisficing, and goofs.
Lawyers have a reverence for provisions that they believe are “market” — that is for provisions that have been around and have not been challenged and thus are assumed to be unproblematic. Even if a lawyer wanted to eliminate some old verbiage, the client might resist. Instead of deleting a clause, the lawyer tries to render it innocuous with additional verbiage. The results can be first, legal incoherence, and second, costly litigation. Sometimes the problematic provisions are borrowed from another contract where they function perfectly well. Imported into the new context, these alien provisions can have a disastrous and unanticipated effect. Another problem with imported language is that it might not be as tried and true as the attorneys think. As the Authors compared standard contractual provisions in multiple contracts, they find multiple deviations. Lawyers thought they were just re-using sacred “market” text. Actually they were adopting a relatively recent creation, a mutation or variation on language that had been used before.
Sometimes, efforts to edit and improve a murky bit of lawyerly prose can give rise to a landmine. Sometimes, the landmines are the product of the parties’ negotiations and, at least in the context of sovereign debt instruments, the sovereign has the bargaining power to insist on ambiguous language that can later become a landmine to be detonated by an opportunistic party.
Part of the problem is transactions costs and the pace at which complex transactions are negotiated. Problematic provisions can be fixed, but fixing them, without causing new problems, requires skill, time, and cooperation. When there is a multi-party transaction and time is short, combining those three elements may be logistically challenging and in any event is a very expensive proposition.
One of the most interesting aspects of the book is that it is an exercise in the sociology of the legal profession. The Authors conducted interviews with over 200 practitioners, whom they divided into the gurus and novices, to help them understand why landmines arise and why they are so hard to prevent. Sometimes novices create mistakes that the gurus catch but cannot correct. The novices may actually be experienced transactional attorneys but they have never deal with, say, sovereign debt instruments before, and they don’t know what they don’t know. Once the gurus find a mistake, they may meet resistance, because of time pressure, because the client has tired of lawyerly tinkering — the risks of litigation were remote —, or because the guru is talking to a novice, too petrified and powerless to authorize changes.
Landmines have always been around, but there used to be a culture of professional courtesy, such that no entity was willing to risk its reputation by detonating the landmine. Those days are gone; there is no honor among creditors. Now, we increasingly see “creditor-on-creditor violence.” Moreover, the current climate of textualist formalism means that courts will detonate a landmine if that’s what the contract says without much consideration to what the parties intended.
The Authors offer no real solution to the problem that they identify. The problem of landmines has been addressed in the M&A context through the work of a network of attorneys that managed to educate their peers about specific dangers, but it is not clear that the intervention can be replicated in other markets. They urge courts to look beyond the words of the agreements to the parties’ true intentions and more strictly police opportunistic behavior, but they point out that the parties to these agreements, like the courts, prefer a textualist approach, because the alternative would involve an intricate excavation of the parties’ intentions through protracted litigation. Moreover, it would be an odd world if ordinary consumers were bound by the terms of contracts that we know they do not read but the world’s most sophisticated parties were allowed to wriggle off a contractual hook of their own design.
The experience in M&A markets may show a path forward. If lawyers can be incentivized to coordinate efforts to educate their peers and eradicate problematic language in “market” contracts, landmines may be unearthed and disabled. Unfortunately, the incentive to do so often comes in the form of an especially disastrous landmine that explodes before it has been detected and disarmed.
The book is a bit of an earworm. I can’t get it out of my head. When I cover cases involving sophisticated parties, there is always a tendency to remark on how these are well-represented parties who must have known what they were doing when they allocated risks in ways that don’t seem to make a lot of sense. That is a perspective relevant to such classics as Nanakuli, Morin Building Prods., Market Street Associates, and Carbon County Coal. Three of those are Judge Posner opinions, but I actually think that just reflects my love of teaching his opinions more than anything else.
In some of those cases, my students and I discuss the complexities of business entities and how it is possible that, notwithstanding their sophistication, the people tasked with contract performance have no knowledge of the contract’s formation. The contract has been sitting in a filing cabinet for years. This book gives me a new perspective, perhaps not on those cases, but on how errors can arise notwithstanding good, conscientious lawyering and well-resourced parties.