The Design of Staged Contracting

Albert Choi (University of Virginia)
George Triantis (Stanford University)

Abstract : In negotiating complex business transactions, parties decide whether, when and how to invite legal enforcement of the rules that govern their relationships, particularly in their use of intermediate agreements that reflect some agreement on a number of provisions but contemplate further negotiation (variously labelled memorandum of understanding, agreement in principle, letter of intent, term sheet). Under the common law of most U.S. jurisdictions, the parties have an intermediate option between enforcement and no-enforcement of such intermediate agreements: a duty to bargain or negotiate in good faith or with best efforts. Law firms warn their clients about the risk of inadvertently bringing on this type of enforcement but with care, this risk is small. Rather, the parties are often unclear about the freedom they prefer for themselves or their counterparties to deviate from the terms of their intermediate agreements. They expect these terms to be sticky to some degree, but do not think through how much and by what means to achieve this. Judges and commentators identify the protection of specific investments as the principal goal of the commitment to bargain or negotiate. We suggest, however, that the benefit of the flexible standard of good faith or best efforts comes more broadly from mid-stream regulation of the negotiation process. The parties need flexibility in optimizing their deal, while also efficiently constraining value-claiming behavior and allocating exogenous risks during their negotiations. Building on our earlier work on strategic ambiguity, we also show that concerns about the uncertainty of such flexible standards can be addressed.

Deal Momentum

Cathy Hwang (University of Utah)

Abstract : When does a deal begin? Does it begin when parties sign a non-binding term sheet? Or only when parties sign a formal contract? This Article uses mergers and acquisitions (M&A) deals to examine why and how parties use non-binding preliminary agreements. It provides the first modern, comprehensive account of how parties use these common, but rarely publicly disclosed, bargaining tools to build deal momentum and carry a deal forward. In M&A deals, sophisticated parties enter into non-binding preliminary agreements. Once parties sign non-binding agreements, however, parties behave as though bound—they almost always follow up with a formal contract that closely tracks the early non-binding terms. Scholars and courts have long treated preliminary agreements as contract-like tools that need to be enforced. This Article develops an alternative theory of “deal momentum” to explain why parties use non-binding agreements. Non-binding agreements are not minor contracts—rather, they are signposts for when enough momentum has accumulated that a deal has become “sticky” and is likely to go forward. Although non-binding agreements are not contracts, they play an important role in facilitating complex contracting through their signaling, organizational, and formal functions. By focusing exclusively on non-binding agreements’ contract-like qualities (their substantive functions), scholars have overlooked their formal functions. Non-binding preliminary agreements can nudge parties toward collaboration and signal seriousness, for example. Reframing preliminary agreements as signposts for deal momentum, rather than as minor contracts, has significant implications for contract theory, contract enforcement, and deal design. It suggests that the theoretical boundaries of the deal do not begin with preliminary agreements, that courts ought not to enforce those agreements, and that parties ought to use them—but as organizational tools, not as contracts.

The Architecture of Contract Innovation

Matthew Jennejohn (BYU Law School)

Abstract : Many contracts, such as the merger agreements studied here, are complex combinations of customized and standardized terms, and thereby achieve economies of both scale and scope. Such contracts are “mass customized,” to borrow a term from engineering research. This Article introduces a theoretical framework and methodological toolkit for studying such complex agreements. With respect to theory, it adds to recent scholarship that applies modularity theory to the design of complex agreements by introducing an alternative approach to harnessing contractual complexity—flexible specialization. Whereas modularity attempts to manage systemic complexity by isolating discrete subsystems from one another and ensuring their interoperability through a set of static interface rules, flexible specialization allows for tightly coupled connections between subsystems, and interoperability is achieved through a suite of explicit and tacit organizational routines that reduce the design team’s communication and learning costs, allowing them to quickly process adjustments across the interlocking sub-systems. Using hand-collected data from samples of public company merger agreements and of the teams of deal lawyers that designed them, this Article presents the results of a preliminary empirical study testing whether the architecture of mass customized contracts reflects either modularity theory or the logic of flexible specialization. Methods developed in systems engineering, organizational theory, and network analysis are used to map the structural topology of the sampled agreements and deal teams. Results of the merger agreement analysis suggest that the contracts are integrated to a material extent, rather than being purely modular systems. Similarly, analysis of the internal organization of the corporate law firms designing those agreements suggests thickly interwoven organizational structures, consistent with flexible specialization’s rich information-sharing routines.

Beyond Boilerplate: Lessons from the Sec’s Regulation of Standardized Disclosure

Jeremy McClane (University of Connecticut)

Abstract : In this paper I analyze how the use of boilerplate language in securities disclosure has evolved in light of the SEC’s attempts at regulating it, and argue that the of use algorithmic language processing and machine learning methods that drive the country’s most innovative companies could also vastly improve the SEC’s disclosure regime. In particular, topic modeling can be used to understand the revealed preferences of market participants with respect to certain kinds of boilerplate disclosure, and enable to SEC to offer a menu of disclosure options for issuing companies. The analysis in this paper suggests that the SEC has had limited success regulating boilerplate because it treats such language in a one-size-fits-all manner. However, as the analysis shows, different boilerplate language performs different functions: some truly is meaningless, and most likely the product of over-conservative drafting, other language is used for efficiency, and still other language is used by issuers to be strategically vague. Natural language processing can be leveraged to identify which boilerplate is useful and which is not, to allow for more nuanced, targeted regulation. In particular, the empirical analysis in the paper does three things: First, it documents and analyzes the mixed results of the SEC’s past efforts to control boilerplate in IPO disclosure. Second, it provides evidence that the use of boilerplate impacts investors, and draws conclusions about the usefulness of various kinds of boilerplate language. Third, it demonstrates how a more targeted approach to boilerplate could make for more successful regulation, as well as more comprehensible disclosure for investors.