Monday, April 5, 2010

How Will Contract Standards Emerge?

A few days ago, I decided to dip my toe into the world of blogging. I've posted three items, in part to see how much effort it is to maintain a blog. Indeed, see if I could keep it up and write something interesting. I thought I would keep it quiet for sometime as I played in own private sandbox. I thought to myself: "no-one will read the first few posts anyway." Obviously, I'm a novice in the world of social media. In fact, I am amazed at the speed of connectivity.

The concept of this blog is simple. Richard Susskind describes the evolution of legal services from bespoke (custom) services to ultimate commoditization. It is the intent of this blog to document this metamorphosis (from the perspective of transactional practice) and, from time-to-time, humbly offer ideas for lawyers to benefit from these changes. I see Richard as eloquently laying out the theory; I propose to discuss how to put his ideas into practice. It may even be seen as self-promotion of my company. I've been working on this stuff for many years, and yes, I'm deeply personally, passionately and commercially interested in this space.

Richard has pointed out that change will occur upon the back of the twin forces of economics and technology. The economics appear to be in place. Is the technology? What technology will drive the revolution? Personally I don’t think its email, communication or social media, or indeed any technology that's generic to all businesses. I think it must be legal-specific. It must be technology, or rather technologies that change the very nature of the business and practice of law. It must automate some or all the tasks and activities specifically performed by lawyers. For example, do you think a better search engine bring about the changes Susskind foresees?

The first step in Susskind's continuum is the transition from customized to standardized services. It sounds simple enough. But, how will this come about? How are standards established?

Joe Bartlett wisely observes: "standardization of model documents remains like the weather; as Mark Twain put it: ‘a topic of general conversation but as yet nobody is doing anything about it,’ or at least without the success the need would dictate."

In general, standards may arise by (a) promulgation by an authoritative body, (b) directive of a party with superior bargaining power, or (c) consensus among a group with common interests. In addition to these methods, I propose another way: by identification of a standard as a benchmark metric.

1. Non-Negotiated Agreements

In fact, the clear majority of legal agreements in existence are standard forms; an agreement type sometimes referred to as contracts of adhesion, where one party presents terms to the other in a form of "take it, or leave it" proposal. These types of legal agreements range from mortgage loans, shrink-wrap or click-wrap license agreements to terms on the back of sports or entertainment tickets.

2. Negotiated Agreements; Common Interests

In the domain of negotiated contracts, there are far fewer examples of standard forms. They are typically limited to circumstances where the parties have shared interests. Complexity is not in itself a factor. Indeed, one of the most complicated documents ever devised has been standardized—the ISDA Master Agreement. This standard form comprises a preprinted master agreement (either local jurisdiction single currency or multicurrency-cross-border), a schedule, and a form of confirmation. It can be quickly adapted to individual transactions without the need for document assembly technology simply by completing the schedule, which serves as a term sheet. In the case of the derivatives market "[s]tandardization of format permits dealers to reduce their transaction costs, and end users who may have relationships with more than one dealer can quickly develop expertise using the ISDA or similar formats and thus reduce their costs as well."
The ISDA Master Agreement - The Rise and Fall of a Major Financial Instrument, Bushan K. Jomadar, University of Westminster - Westminster Business School; University of Westminster - School of Law, August 24, 2007.

Other industry groups have joined together to establish standards in their market, notably the American Institute of Architects. According to their web site, the
AIA provides "a comprehensive suite of contractual documents that address the full spectrum of design and construction projects, large and small." In addition, a handful of publishers offer Master Specifications for all build projects (e.g. ARCOM). However, in the field of negotiated agreements, the ISDA and AIA standards are more the exception rather than the norm.

3. Negotiated Agreement; No Ongoing Shared Interests

The majority of agreements drafted and negotiated by attorneys in private practice are negotiated. They are typically drafted based on prior precedent; the "last draft" approach. While it is pragmatic, it also brings forward the good, the bad, and the ugly. Moreover, improvements are not systematically collected; they are more frequently lost to the black hole of electronic filing systems.

While there is clearly room for debate on the merits of the last draft approach, we do have means to measure contract consistency, whether manually (as detailed in the blog post describing
empirical analysis of contracts) or with statistical tools (such as those developed by kiiac). Based on these methods, how far are we from standardization today? A long way. One of my yardsticks is the simple seemingly innocuous governing law clause. When we analyze a set of agreements from a single firm, we will rarely find two clauses exactly the same. Since at least some of these documents were based on the last draft, it means that someone specifically edited the language. And in my opinion, virtually all the edits are semantic; the intent of the clause is largely unchanged. And, even if revisions do need to be made, why not pre-define one or two standard variants? Or better still; why not create a range of standardized Miscellaneous provisions. What about the Reps, the Covenants, and indemnities?

But if it is difficult in practice for lawyers in a single firm to agree on consistent language, there seems less hope for market standards. Or perhaps we need to recognize that dogmatic definition of the exact words is not realistic as an initial step towards standards. Perhaps we should think of legal agreements more like recipes in which we can recognize the basic ingredients, proportions and methods of preparation, but each chef will introduce its own variations.

A standard under this formulation is a yardstick; a metric that can evaluated on a number of different scales. It might measure, example:

  • Bias: the degree to which the contract is weighted in favor of one party or the other;

  • Clarity: the degree of readability, such as the Flesch–Kincaid readability test; (e.g. EULA Analyzer);

  • Legal Risk: the degree to which the agreement conforms to, or diverges from, available statutory or common law; and

  • Business Risk: the degree to which the terms conform to, or diverge from, market standards.


  1. Kingsley –

    I think residential mortgage loan documents, which you label as contracts of adhesion, could be an interesting case study for you.

    Although fairly standard now, that was not true before the mid-1970’s. The securitization of residential mortgage loans by Fannie Mae and Freddie Mac created the standardization process. In order for those agencies to move a large number of loans through their system, they needed the documents to be uniform.

    On the other hand, the recent surge of commercial mortgage loans did not create a similar standardization of the documents. The one exception is the subordination agreement between the senior mortgage lender and a junior lender. S+P hired a law firm to create a model for that situation and it was widely used.


  2. Kingsley, I'm excited to discover your blog (thanks to a tweet from Doug). You've mentioned a few things here that I haven't heard in recent blogosphere discussion around standardization of financing term sheets and documents for startup tech ventures (a topic I'm trying to think through on my blog). Very much looking forward to your posts.

  3. Doug,

    I would very much like to run an analysis of mortgage loans. I have had only a few opportunities to process finance documents. From this limited perspective, I have found that commercial lending documents tend to exhibit a moderate degree of consistency; they are certainly less consistent compared to residential loans.

    An in-depth analysis might also uncover blocks of standards in commercials loans probably originating from each lender's standardized format. I have certainly seen this "gnome-type" grouping in licensing agreements, with which I am more familiar.

    I think it is also probably fair to say that today's commercial loan agreements are probably twice as long compared to a comparable document in the 70's.

    If I get the chance to run a deep analysis, I will share the results with you.

  4. William,

    Thanks for your email. If you are interested, I would be pleased to collaborate with you in a project to analyze financing term sheets and documents for startups. Being a startup myself, it’s a topic close to heart.

  5. Kingsley, you bet, I'm interested. I think that would be important and fun.