Tuesday, December 21, 2010

Contract Readability -- Part 2

Contract readability is affected not just by the choice of words (common or obscure) or sentence structure (short or long and compound) but also by style. In their landmark work, What Makes a Book Readable (1935), William S. Gray and Bernice Leary identified 228 elements that affect readability, which they classified into four main headings:

  1. Content
  2. Style
  3. Format, and
  4. Features of Organization

The authors found that content, with a slight margin over style, is most important. Third in importance is format, and almost equal to it, “features of organization,” referring to the chapters, sections, headings, and paragraphs used to organize concepts and ideas.

The golden rules of human readability are generally well understood. JoAnn Hackos and Dawn Stephens in Standards for Online Communication (1997) summarizes the rules:

  • “Use short, simple, familiar words
  • Avoid jargon.
  • Use culture-and-gender-neutral language.
  • Use correct grammar, punctuation, and spelling.
  • Use simple sentences, active voice, and present tense.
  • Begin instructions in the imperative mode by starting sentences with an action verb.
  • Use simple graphic elements such as bulleted lists and numbered steps to make information visually accessible.”

However in many cases, drafters of legal agreements appear to go out of their way to violate these principles and make their documents more difficult to read. There are numerous ways drafters challenge human—and machine—readability.

  • Compound Clauses aggregate multiple clauses into a single clause (e.g. Governing Law; Venue; and Jurisdiction)
  • Overlapping Clauses are a variation of compound clauses that inconsistently combine clauses (e.g. (a) Entire Agreement; Amendments and Waivers, (b) Entire Agreement; Waivers, and (c) Amendment and Waivers)
  • Duplicate Clauses are similar clauses found in different parts of the agreement (e.g. Best Efforts and Further Assurances in the Transaction, Covenants and Miscellaneous sections)
  • Inconsistent Organization of Clauses occurs when articles are inconsistently named and grouped (e.g. Covenants, Covenants of the Buyer, Covenants of the Seller, Additional Agreements, Additional Agreement and Covenants)
  • Inconsistent Location of Clauses occurs when a clause appears in different sections of a document (e.g. an Amendment clause may appear in either the Miscellaneous or the Termination section)

When clauses are sometimes located in one place and sometimes elsewhere, there is a higher likelihood that important clauses may sometimes be missed.

Based on these principles, there is a set of clauses in legal agreements that are consistently the most inconsistently organized. The identity of these clauses will likely come as a surprise, because they are also some of the most basic provisions. They are the opening clauses in the Representations and Warranties section that cover the following concepts.

  • Status
  • Powers
  • No Violation or Conflict
  • Consents
  • Obligations Binding
Frequently these concepts are joined in every combination possible.

Atul Gawande’s Checklist Manifesto provides a detailed analysis of the use of checklists by professionals, including physicians and pilots. The author demonstrates how such simple lists can improve performance. As mentioned in an earlier post, the organization of a contract can also serve as a deal checklist. Moreover, the application of some simple rules can make contracts more readable and less prone to oversight.

  1. Organize sections in a logical (business-orientated) manner
  2. Apply a consistent organizing framework
  3. Separate elements into their most basic constructs
  4. Use numbers, bullets and other formatting methods to visually separate contract elements

Tuesday, October 26, 2010

Margin, Volume, and the Long Tail

Private law firms naturally focus on high margin services—bet the business work—where cost is less of a concern and fees are high. However, such work is small in volume. While mostly shunned, there is significant opportunity in more routine factory work. While it carries a low margin, the smaller profits per transaction are more than made up in volume.

The topic was addressed in one the best presentations at ILTA. Gerard Neiditsch, Jeffrey Rovner, Mary Abraham, and Ron Friedmann took A New View of the Automated Law Firm and contrasted the nature of bet the business and factory work from a wide range of perspectives, including: (a) how work is produced, (b) how it is managed, (c) who does the work, (d) how business is developed, (e) how it is priced, and (f) how the work is packaged.

Margin, volume …

With an hourly rate, profit margins tend to be similar for bet the farm and factory work, because profit margin today is based more on the staffing ratios and hourly rates than the nature of the service.

While more hours and higher priced attorneys will likely be applied to a merger transaction compared to drafting an employment agreement, meaning that the gross receipts will be higher for the merger, the profit margin for each hour worked will be equivalent where staffing ratios of partners, to associates, to paralegals is about the same. In the absence of a successful document automation or legal process management solution designed to delegate work to less costly resources, the employment agreement will still be handled by a partner and an associate working in about the same ratio of hours compared to the merger.

As a sidebar note: an employment agreement is less standardized compared to a merger agreement, so on a page-by-page basis, it will likely take longer to review and negotiate.

The price for legal services is unresponsive to market forces due lack of automation and process management. As a result, the supply curve is inelastic because of inability to scale or realize any economies of scale.

Economics would argue that since there is a much greater demand for employment agreements, there should be more service providers competing to meet market demand: and, all things being equal, more demand and increased supply will lower the price. Law, however, is high price piecemeal work that requires more workers and hours to produce more services. Lacking innovation, it cannot serve commoditized markets.

Big law serves the narrow market of high-margin, low-volume legal work—good work if you can get it.

Plotting margin and volume on a grid shows that big law operates in the lower-right sector. Few businesses will have any interest in occupying the lower-left sector, and economics will rarely allow the upper-right sector to exist for long periods. In its heyday, credit swaps and derivatives may have been an example of this segment, but most firms continued to price their services by the hour and therefore did not realize higher profits.

The remaining sector is the upper left—low-margin, high volume legal services: a virtually untapped market for private law firms.

... and the long tail

Due to inability to realize economies of scale, big law services fewer and fewer of the transactions executed by their clients because they have priced themselves out of the market. This work has moved in-house.

High margin legal services represent the rarified end of the long tail. For every merger agreement executed by a large corporation, it will negotiate a handful of procurement and license agreements, hundreds of employment agreements, and perhaps thousands of confidentiality agreements. As GCs seek to reduce their outside counsel expense by as much as 25%, this trend will likely accelerate.

The opportunities for law firms (big or otherwise) able to introduce efficiencies are significant. Moreover, this untapped market is likely far larger than the market currently served.

There are many good reasons why firms may not choose this path. It will require change and investment. It may also be perceived as less challenging commodity work. Having spent years drafting and reviewing legal documents, I would argue that is just as challenging to identify contract standards and negotiation ranges for employment agreements based on thousands of documents, compared to drafting one merger agreement.

Friday, October 1, 2010

Contract Analysis -- Commonality and Consistency

In response to my last Post, Ken Adams returns to a familiar theme to question the contract analysis approach. His post, http://www.adamsdrafting.com/2010/09/30/for-optimal-contract-language-dont-follow-the-herd/ suggests the purpose of contract analysis is to find the most popular clauses.

This is an opportunity to clarify how kiiac works. In creating a reference set, kiiac creates an aggregated outline (similar to a table of contents for the collection) and a clause library for each outline branch. The outline captures the standard transaction elements and all deal-specific variations. It does, indeed, measure clause commonality, showing how frequently particular terms appear in the collection. The clause library, however, is organized not by commonality, but by language consistency. Our goal is to find the core, non-negotiated language for each provision. We then group the library by conformity to the standard, highlighting deal-specific or divergent terms in each clause. Typically all the clauses are slightly different, so it is difficult to determine which would be the most common.

kiiac proposes the core language as a starting point. You can select a different clause if it contains language you prefer, or you can quickly review the full range of alternatives and supply your own language for the provision.

Ultimately, the difference in approach between Koncision and kiiac may not be that different. kiiac’s approach is to start with a document structure and set of clauses that are familiar to the attorneys, identify the best precedent in the collection and enable a process of continuous improvement. As I understand it, Koncision will use existing precedent as a guide and may re-write terms where existing language is not optimally suited for its purpose. I think it is fair to say: we are both trying to get to the same point.

Figure 1 shows the outline created for a merger agreement, showing the organization of the agreement of the agreement and how frequently each provision occurs (the more common the clause, the more filled-in the icon).

Figure 2 shows the clause library for the governing law provision, identifying the core clause with the least or no deal-specific or negotiated language, and grouping the clauses by divergence to such standard.

Thursday, September 30, 2010

The Power of Statistics

We all know the catch phrase “lies, damned lies, and statistics.” It is typically used to mean that statistics can be manipulated to support any proposition and should therefore be viewed--presumably--with some degree of skepticism.

And that’s a concern for those of us seeking to harness the power of statistics to analyze contracts and other documents.

So I was intrigued when I came across Michael Lewis’s book Moneyball-The Art of Winning an Unfair Game (2003). I enjoyed Liar’s Poker (1989) and look forward to reading The Big Short: Inside the Doomsday Machine (2010). I confess to reading a synopsis of Moneyball on Wikipeadia. It summarizes the book:

“The central premise of Moneyball is that the collected wisdom of baseball insiders (including players, managers, coaches, scouts, and the front office) over the past century is subjective and often flawed. Statistics such as stolen bases, runs batted in, and batting average, typically used to gauge players, are relics of a 19th century view of the game and the statistics that were available at the time. The book argues that the Oakland A's' front office took advantage of more empirical gauges of player performance to field a team that could compete successfully against richer competitors in Major League Baseball.”

The application of math and statistics to literature, art, and even sports is often greeted with skepticism, doubt and sometimes nostalgia. For example, Bill Simmons of ESPN writes in Finally joining the revolution: “I longed for the old days when you could say things like, ‘I hate watching J.D. Drew -- when is that contract going to end?’ and there wasn't some dude lurking behind me with Drew's stellar OPS, VORP and WAR numbers saying, "Well, actually ... "

Simmons is now a convert and is convinced by the insights offered by sabermetrics.

Reading these articles also made me think of a piece in the Wall Street Journal titled, Contract Doesn't Let Board Fire Mann CEO for Jail Term, in which the authors appear outraged that “[u]nder the terms of the employment agreement for Louis Lower, the jailed chief executive of Horace Mann Educators Corp., serving a 60-day sentence on a drunken-driving charge isn't grounds for firing—or for losing any pay.”

If the authors harnessed the power of empirical evidence, they would discover that termination for substance abuse is rare, appearing in less than 5% of CEO contracts. Stewart J. Schwab and Randall S. Thomas report on their analysis in An Empirical Analysis of CEO Contracts: What Do Top Executives Bargain For?

Some contracts may include commission of a felony as cause for dismissal and termination of pay; but typically a DUI is a misdemeanor and in some states it carries a mandatory jail sentence.

While contract analysis is a very new field, it will likely offer new insights on precedent that we thought we understood thoroughly and it may question our long-held beliefs.

Tuesday, September 21, 2010

Creating Forms by Committee and Consensus

An earlier post—The Fastest Way to Create a Form—describes a process to identify standards using technology to find the most conforming document and the most conforming clauses to quickly establish a baseline and then bring it up to practice standards by supplementing the baseline with missing and divergent clauses.

In other cases, a consensus building approach might be preferred. Working with ABA Model Intellectual Property Task Force, we have proposed an efficient, technology-enabled approach to develop model forms based on a potentially diverse set of documents and a wide range of individual interests.

1. Create the reference set from a source set of documents. In this case kiiac examined 105 Intellectual Property Security Agreements. (If you are interested in viewing the set, please send me an email and I will provide you with access credentials).

2. Provide an overview of the process. John Murdock, partner at Bradley Arant, created a YouTube video explaining the goals of the project and how the group can achieve consensus and develop the model form. John created the video in PowerPoint and rendered it with Moyea PPT to Video Converter. (FYI: A good resource for ideas about putting PPT content on the web is: http://www.dvd-ppt-slideshow.com/ppt-to-dvd-tips/put-powerpoint-on-web.html.)

3. Gather feedback on drafting options. The consensus building approach needs to work both during in-person meetings (that may take occur twice a year) and between such dates. In order to move the process along more efficiently, the key drafting choices are identified and the group’s opinions gathered through a Survey Monkey.

The approach to identifying the drafting questions used the technology to examine where consensus exists and where there is a range of opinions. One of the goals of the MIPSA project is brevity. While it would be easy to use the technology to identify all possible variants and string together a comprehensive lists, the group determined to use the process to streamline and clarify contract language.

Where kiiac finds that all documents contain a particular provision, it is considered required. But where a particular provision is found in the some, but not all agreements, it is considered optional or deal specific. The group is then asked whether it should be included in the model. For example, 100% of the grant clauses contain a grant of a security interest, while a smaller percentage include language to “assign,” “pledge,” or “hypothecate” the collateral. Here is a screen shot of the Survey Monkey.

The first step to create a model for the grant clause will run through December. I’ll report back on the results and level of participation.

Monday, September 13, 2010

Contract Readability -- Part 1

What makes a document easier to read and understand by both humans and machines? Does readability—or lack thereof—affect document quality?

The next few blog posts will focus on drafting practices to assure quality and avoid mistakes. The purpose is to try and identify best—and worse practices—and discuss whether they have any significant impact on quality.

The golden rules of human readability are generally well understood. JoAnn Hackos and Dawn Stephens in Standards for Online Communication (1997) summarizes the rules:

  • “Use short, simple, familiar words.
  • Avoid jargon.
  • Use culture-and-gender-neutral language.
  • Use correct grammar, punctuation, and spelling.
  • Use simple sentences, active voice, and present tense.
  • Begin instructions in the imperative mode by starting sentences with an action verb.
  • Use simple graphic elements such as bulleted lists and numbered steps to make information visually accessible.”

But, lawyers, as typified by a well-known Dilbert cartoon, are well known to violate each rule with reckless abandon.

There’s a fabulous site you can use to test the readability of your contracts.

Online Readability Test

It estimates the number of years of formal education required to understand text on first reading using the Gunning Fog index. The software reported that for one merger agreement I processed, you will need nearly 23 years of schooling. It will be interesting to discover the most incomprehensible document.

Contractual clarity has long been the goal of the Plain English movement. But, it has made only limited progress. In the next post, I’ll address whether readability matters.

Thursday, September 2, 2010

The Fastest Way to Create a Model Form

We all know the most inefficient method: ask attorneys for their best samples and form a committee to review the documents. Virtually all firms have tried this approach: all with same result.

Now, with aid of technology, there are much more efficient methods that can produce a model document in days; sometimes hours.

1. Search the document management or file system for the desired document type. Vetting or editorial review is not required. The software should identify the required documents and parse the clauses to identify the core, non-negotiated language.

2. Analyze the set of documents and

· capture the document outline, indentifying the frequency of each provision;

· capture a library of clauses for each provision, identifying language consistency

3. Find the most conforming document. This is the document that contains all common terms and the most standard clause language. Most importantly, it will have been drafted so that all its clauses and defined terms work together. It is also useful to confirm that this model is also widely used at the firm (i.e. are there a number of similar documents). If so, it is not only the most conforming document, but also the de facto standard.

4. Find the clauses in the most conforming document that might be missing. These are the clauses that occur frequently in the document set, but are absent from the most conforming document. Determine whether to add the most conforming clause from the clause library or another clause example, if desired.

5. Find the clauses in the most conforming document that diverge from the standard core language. These are the clauses that may be missing some standard language or may contain deal-specific language. Determine whether to replace these clauses with the most conforming clauses or another clause example, if desired.

In a recent application of this approach, one top-level clause was indentified as missing and four clauses were identified as divergent. The lawyer review process to create the model form took 45 minutes.

Wednesday, September 1, 2010

A concise history of the use of forms in the legal profession

The earliest use of model forms can be traced back to 1392, when the Worshipful Company of Scriveners first employed scribes to beautifully copy one document to the next. WHEREAS, the aforementioned forms were penned in Ye 'Olde English, the innovation is remembered mainly for its use of hand-scrolled, script font.

In these early years, the pace of innovation is swift. The next major milestone came in 1450, when Gutenberg invents the printing press, enabling the mass production of form books. In terms of drafting practice, the distinguishing feature of the innovation is the use of the blackletter font.

However, for nearly 400 years innovation is shunned as drafting enters the dark ages. It is not until 1829 that the next major innovation arrives with the invention of the typewriter, enabling lawyers to mass produce their own forms. The innovation is distinguished mainly by the eventual adoption of the courier font.

Finally, in 1976, Jobs and Wosniak invent the personal computer, facilitating the automated mass production--and personalization--of legal forms. However, most contracts are still drafted by copying the last document and laboriously making the necessary changes for the next client. The key innovation is the wholesale transition from a fixed width to a proportional font with the introduction of Times New Roman.

One can only imagine what new discoveries will be made in the centuries to come.

Tuesday, August 31, 2010

ILTA-When will lawyers find the time to practice?

ILTA was a great experience: totally exhausting. Overall, I agree with Peter Krakaur’s (CKO Orrick) assessment that the presentations clearly showed we are embarking on a period of significant change, but also a renewed sense of energy or excitement.

For 10 years, there has been little new to talk about. There have many great ideas, but few instances of real change. For example, it was rare to see screen shots of examples of KM in practice (by which I mean not simply search and retrieval). Now there appears to be broad acceptance that change is happening, a few firms are embracing alternative billing and some are even moving towards performance based review for associates (not just number of hours).

To this new world, comes new technology such as profitability analysis and project management. Session after session highlighted new technology and placed some or all the burden of adapting to the “new normal” on the attorney. I began to wonder when lawyers will find time to practice. After 30 years of innovation, we require attorneys to be:

  • Competent secretaries
  • Skilled researchers
  • Adept at numerous software applications
  • Seasoned marketers, and
  • Capable project managers

Lawyer circa. 1980

Lawyer 2010

We may need to start asking ourselves how many of these tasks can be offloaded to dedicated professional staff or handled by technology.

Monday, August 9, 2010

Contract Analysis—A Force for Contractual Bloat or Streamlining?

I would like to believe a significant event took place over the weekend in San Francisco—contract analysis moved beyond static surveys to serve as an interactive tool to evaluate and guide best practices.

In a session at the ABA Conference, John Murdock, a Partner at Bradley Arant Boult Cummings LLP and I presented an analysis of 105 Intellectual Property Security Agreements. I provided the statistical analysis; John presented the legal analysis of the documents. John titled his talk: "Did 29% of the lender's get it wrong; or did the rest of us blow out some IP." Here are links to John's and my presentations.

Our process as part of a Task Force to develop a model form was to:

(a) determine the structure of the form by identifying required and optional elements of the agreements;

(b) determine the content of each element by identifying the range contractual language; and

(c) establish a procedure for members of the task force to express their opinions as to why each optional provision and term should be included or excluded from the model.

For example, in the case of the grant clause, 100% of the agreements contain a grant of the security interest. Each optional additional elements is shown in italics and its frequency is displayed in parenthesis.

Borrower irrevocably grants to Secured Party a continuing security interest in and

pledges, (42%)
assigns, (23%)
hypothecates, (19%)
mortgages, (12%)
grants a lien upon, (5%)
and grants a right of setoff against, (9%)
the Collateral
with power of sale (8%)

The discussion raised the interesting question, will contract analysis tend towards producing ever longer agreements or will it be a force to consolidate language? I hope it is a means to rein in language bloat. Indeed, this is process we hope to put in place.

The mechanisms to push toward comprehensiveness and streamlined agreements both exist in the software. The tools to create the agreement structure will find all standard contract elements and all deal-specific variants. The tools to examine the contractual language for each provision identify the core, non-negotiated language and all variations. Whether the tool is used to find the model that seeks to address all possible contingencies or succinctly and clearly address the specific needs of the transaction is in the hands of the user (or committee).

Contract analysis tells you what provisions are required—they appear in 100% of the documents—and what provisions are optional. The Task Force plans to review each provision and all language and justify why each term needs to be in place, rather than simply take the approach that others have used the terms, therefore they must be important under some circumstances and should not be removed.

The capacity to review and analyze legal agreements has always existed. We can read large sample sets of documents, tabulate and publish the results. Automated systems can do it much faster (KIIAC can process the 105 agreements in less than 2 minutes). It can do it across all deal terms and in great detail. There is, however, a more subtle difference.

Computer analysis does not simply collect information on the frequency of occurrence, it gives us the capacity to easily examine the full range of alternatives and make judgments about which will deliver the better results. The observation might simply be that best practices are more easily identified when we are exposed to a dynamic and interactive medium compared to viewing static survey tabulations.

Monday, July 26, 2010

How do your forms stack up to practice?

Recently, our contract analysis work raised an interesting question: how do commercial forms measure up to practice standards? In this circumstance, practice standard is defined as the best precedent files available from a law firm's document management or file system.

In summary, we discovered model forms contain less deal variations and fewer deal specifics. In one case—an asset purchase agreement—analysis showed that the commercial form contained about 50% of the firms standard terms and clause language.

For example, comparing the sub-clauses of the section captioned Purchase and Sale of Assets, the commercial form, as shown in the table, contains the basic deal elements, while the firm standard details included and excluded assets and liabilities, together with specific price allocations and adjustments.

Commercial Form

Firm Standard

Purchase and Sale of Assets

Transfer of Assets

Assumption of Liabilities

Excluded Assets

Purchase Price

Assumed Liabilities

Excluded Liabilities

Purchase Price

Payment of Purchase Price

Allocation of Purchase Price

Adjustment of Purchase Price


The same differences can also be seen in the text of clauses. The commercial form provides minimal language for the purchase and sale of the assets.

"Purchase and Sale of Assets. On and subject to the terms and conditions of this Agreement, Buyer agrees to purchase from Target, and Target agrees to sell, transfer, convey, and deliver to Buyer, all of the Acquired Assets at the Closing for the consideration specified below in this 2."

The firm standard provides more details and specifics. For example in the case of the sale of assets of a high tech company, the clause provides great detail on all assets and provides a list of assets transferred including: (a) personal property; (b) raw materials and work in progress, (c) contractual rights, (d) claims, (e) intellectual property, (f) works, (g) designs, concepts, know-how and techniques, (h) permits and licenses, (i) books and records, (j) computer programs and associated data, and (k) goodwill.

Measuring Standards

By way of background, contract analysis software performs two principal tasks. First, it creates an aggregated outline (or checklist) from a set of documents. Second, for each outline element, it creates a clause library. As part of this process, the software identifies the best document and the standard clauses. "Best" is, of course, subjective. Contract analysis, like any other computer process defines such standard as the best objective or logical approach.

Finding the Standard Document

The most conforming document is the document that contains all standard deal elements and the least deal-specific variations. It is compares documents based on three main statistical elements, simplified here for purposes of explanation.

  • First, the presence of articles, clauses and sub-sections, namely the building blocks of a deal document. For example, the analysis identifies whether each document has survival, amendment and waiver clauses, irrespective of where they may appear in a document. It also identifies and counts the number of deal-specific clauses that do not typically appear in a particular type of document. The ratio of standard to non-standard clauses gives us the clause commonality measure.
  • Second, for clauses that have sub-sections, the analysis measures the commonality of such sub-clauses. For example, in a merger agreement, it finds and groups all possible representations and warranties and how frequently they occur. The ratio of common sub-clauses to non-standard clauses provides a measure of sub-clause commonality.
  • Third, the analysis measures the commonality of the words in each clause. The analysis identifies the common and infrequent words. The ratio of common words to uncommon words in each matching clause gives us the measure of word commonality.

The document with the highest overall score is the most conforming or standard document. It is, in fact, the document containing all the standard deal terms.

Finding the Standard Clause

The approach to finding the standard clause is not the most common or frequently occurring clause. It is the clause example that contains all required language (determined by analyzing all matching clause examples) and the least amount of deal-specific language. In plain English, it is the clause that contains the core, non-negotiated language.

As an aside, when working inside law firms, it was frequently suggested that best practice precedent should be drawn from the first—and not the last—draft of an agreement, presumable based on the reasoning that it will be the least edited and changed from base standard. Contract analysis exposes the weakness of this approach because in many cases the so-called "first draft" is in fact brought forward from the last draft of the agreement used as a starting point for the new document. The way to find the core, non-negotiated language is to examine all clauses from all documents and identify the most conforming language.

Efficient Forms Creation and Maintenance

The result of this analysis is not theoretical. It has practical value, significantly speeding up the process of forms creation and maintenance.

First, find the most conforming document. In this document, all the clauses will be drafted to work together with a conformed set of define terms.

Second, for those clauses that may be missing or divergent from the standard (in this particular document), use the clause library to supplement of replace the clause. Where the most conforming document is 90% standard, the review process need only focus on the non-conforming 10%.

Monday, June 28, 2010

Legal and Business Risk—an evolving understanding

Assessing legal and business risks in a transaction and handling those risks in deal documents is without doubt the one of the most challenging tasks a lawyer performs. Moreover, academic and professional writings indicate an evolving understanding of risk. For example, an IACCM newsletter in June 2007, noted "a growing body of evidence indicating that traditional legal approaches to the management of risk are too narrow. They can frequently result in unintended consequences that themselves represent risk to the business. Best practice organizations are tackling this by greater integration of the Law Department into the business and through more rigorous evaluations of probability and consequence, undertaken by people or teams with cross-functional skills and perspectives."

The IACCM initiative seeks to address "three core causes of weakness in existing procedures:

1) Predominant focus on consequence, rather then probability;

2) Narrow situational view, rather than assessment on a portfolio basis;

3) Failure to integrate legal decisions with overall business impacts."

In a similar sentiment, Jones Day partners Robert Profusek and Lyle Ganske published an article titled "It's Time To Rethink The Lawyer's Role In Dealmaking: Start By Facing Up To The New Realities." In the article they state "rather than staying mired in the world of cookbook dealmaking, we need to take a page from the private equity playbook. Our clients need to assess risk."

A Framework for Transactional Risk

In a draft paper, Management of Legal Risk by Financial Institutions, Roger McCormick defines legal risk as "the risk of loss to a company that is primarily caused by:

(1) a defective transaction;

(2) a claim (including a defense to a claim or a counterclaim) being made or some other event occurring which results in liability for the company or other loss;

(3) a failure to adequately protect assets owned by the company; or

(4) change in the law."

While lists of types of risk are helpful to understand the overall breadth of a topic, an organizing framework can further organize and categorize the principal risk elements, so that we might better understand the component elements, their scope and importance. A proposed framework divides transactional risk into legal and business risk.

Legal RisksBusiness Risks
Enforceability Risk: Risk of illegality, unenforceability or increased exposure to litigation
Due Diligence
Divergence Risk: Risk of failure to protect assets, rights, or interests
Compliance Risk: Risk of failure to comply with procedural or regulatory requirements
Negotiation Risk: Risk of failure to secure best terms or unintentionally allocate risks.

First, substantive legal risk raises issues of enforceability. It is the risk that failure to conform to statutory or common law norms may render all or a part of an agreement illegal, unenforceable, or increase the probability of dispute or the cost of resolution. Substantive risks also include the danger that contract terms are not read as intended.

Second, procedural legal risk raises issues of process. It is the risk that failure to comply with procedural of regulatory practice may void, delay or increase the cost of a transaction.

Third, business form risk raises issues of due diligence. It is the risk that failure to conform to market practices and include all required terms may not adequately protect each party's interests. For example, a loan agreement may not adequately indentify the collateral, or a software development agreement that lacks an acceptance clause may limit the buyer's options in the event that application does not perform as expected.

Fourth, business negotiation risk raises issues of customization. Each contractual term—price, process, rights, obligations, remedies, etc.—may have neutral weighting or may favor one party or the other. Negotiation risk is the risk that a transaction fails to maximize each party's interest (relative to their negotiating position) or may unintentionally shift risk between the party's (not reflected in the price).

Initial Thoughts

A review of recent articles and posts indicates a slow shift of focus from purely legal risk to a deeper understanding of the business risks in the transactional practice. Over the next few posts, I intend to dig deeper into each risk quadrant and welcome your thoughts and feedback.