The following article is a reprint (with minor editorial changes for clarity) of a series of 3 articles published in Business Law Today’s May, June, and July 2016 issues. These articles examine LEAN techniques, data analysis, and modern social science to provide practical recommendations to improve business lawyer performance and satisfaction.
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Today’s business lawyers face a toxic paradox of increasing demand for their services with fewer resources to do the job. To combat this problem, a nascent movement is advocating rigorous data gathering and analysis with practical application to business law, using tactics popularized by LEAN and Sabermetrics that have revolutionized manufacturing and baseball, respectively. Sections I and II in this article practically demonstrate how LEAN-inspired thinking can tactically deliver better performance, savings and efficiency. Section III of this article shows that, while combining data with continuous improvement approaches are valuable, the key to unlocking the potential of business lawyers lies not in empiricism and numbers, but in determining what motivates us as people.
I. The Moroccan Souk and Your Commercial Contract Headaches: How Haggling for Trinkets Relates to Limitations of Liability, Insurance, and Indemnity Clauses
A long time ago, I was a Peace Corps volunteer in Morocco. In rural Morocco, the most popular place to buy things is at the “souk,” a weekly combination farmers/flea market where you can buy such things as spices, souvenirs, and used books. One fundamental rule of the souk is that there are no set prices—everything is negotiable. After the Peace Corps, I went to law school, then worked for business law firms and big companies where I learned that negotiating the key pressure points in commercial contracts—limitations of liability, insurance, and indemnity provisions—is as arbitrary, time consuming, and maddening as negotiating for trinkets in the souk. Although you cannot avoid unnecessary negotiations in the souk, there is a practical way to avoid the waste and frustration inherent in contract negotiations regarding these provisions: eliminate the provisions entirely. Despite what you might have heard, doing so is often the best option for your client.
Some Data and Personal Experience
Business lawyers and other professionals who negotiate commercial contracts say that they routinely waste their time negotiating terms that have little impact. For the last 13 years, the International Association for Contract & Commercial Management (IACCM) has been tracking the Top Terms in Negotiation, an annual report based on data gathered from professionals from all over the world who work with commercial contracts, which includes the following side-by-side comparison of the “most negotiated term” versus the “most important term”:
This chart perfectly illustrates what commercial contract professionals are spending their time negotiating versus what they believe they should be spending their time negotiating. Year after year, limitations of liability and indemnification both rank at the top of the “most negotiated term” list, while consistently ranking below that on the “most important term” list. The conclusion from this data is clear—negotiating limitations of liability and indemnities destroys value relative to other, more important terms.
The same conclusion is evident for many of the other commercial contract provisions, but we will include insurance in this discussion because insurance often becomes entangled with limitations of liability and indemnification in a negotiation (insurance appears as number 16 on the most negotiated list and below number 20 on the most important list for 2013–14). For example, typical concerns might include whether the insurance policy covers consequential damages, whether the insurance policy covers indemnification of the other party for damages arising from our negligence, and whether we should limit our exposure to our insurance limits.
Look at the following sample contract provision—a practical example of how limitations of liability, indemnification, and insurance are often mixed into a single, toxic stew of contract confusion:
“Each Party shall be liable for and shall indemnify the other Party against any and all claims, expenses, losses, damages, and costs sustained and/or incurred by the other party as a result of any: (a) breach of the other Party’s obligations, covenants, commitments, warranties, and/or representations set forth in this Agreement; (b) Negligent, wrongful act or omission by the Party or any of its employees, agents, and representatives in the course of or related to its obligations as set forth in this Agreement; (c) Fraud, dishonesty, misrepresentation, and/or default by the Party; and/or (d) Loss of or damage to any property or injury to or death of any person arising as a result of any of the sub-articles (a) to (c) mentioned above. In order to cover its liability under this agreement, the Seller shall take out and maintain at its expense, during the term of this agreement, Employers Liability insurance with limits of not less than $2,000,000 per accident, $1,000,000 per employee, and Commercial General Liability insurance, with limits of not less than $5,000,000 per occurrence and $5,000,000 general and products completed aggregate. Neither Party shall be liable to the other Party for any consequential, incidental, or punitive damages, or for loss of profit and, in any event, each party is liable to the other party for no more than $100,000.”
GREEN—LIMIATION OF LIABILITY
This is a mess! This kind of provision often has a real, negative, and costly impact on business negotiations. I have seen multimillion-dollar deals delayed because the parties could not agree on a provision like this, resulting in millions of dollars in loss to both the buyer and the seller. I have also seen many instances in which the parties go ahead with the deal even though the contract remains unsigned because there is no agreement on this provision, creating ambiguity around the terms of the deal if something goes wrong before the parties can reach a solution. Still, if a compromise is eventually reached on the provision and the contract is signed, the compromised provision often has little real, practical benefit to either party.
I have also seen colleagues spend hours performing an academic dissection of these clauses or, incredibly, hiring outside law firms to draft memos analyzing the meanings of these provisions, case law governing their interpretations, and their purported benefits. For what purpose? No one, not even this author, disputes that each of these provisions are theoretically beneficial, but the drawbacks of including these provisions in commercial agreements outweigh the benefits in the vast majority of business deals.
So what solution is there for the waste, expense, and delay caused by these contract provisions? Many of the so-called solutions that I have heard for resolving these issues amount to gimmicks, horse trading, and attempts to outsmart the other party. Instead of playing games, we can mitigate the problems caused by these provisions by drastically reducing our use of them and, in many cases, eliminating them altogether. Before we can reduce our reliance on these clauses, however, we must look back into the history and origins of common law governing contract breach and damages and examine the implications for our clients of reducing our reliance on these clauses.
The fundamental principles of recovering damages for common law breach of contract were famously articulated in the English case of Hadley v. Baxendale, (1854) 156 Eng. Rep. 145 (Court of Exchequer). In that case, the plaintiffs owned a mill that was shut down because of a broken crankshaft. The plaintiffs went to a carrier company (the defendant) to have the broken crankshaft delivered to the crankshaft manufacturer for repair. The defendant delivered the broken crankshaft to the manufacturer later than promised, causing the plaintiff’s mill to be shut down longer than anticipated. The plaintiff sued the defendant for the losses caused by the mill’s shutdown due to the defendant’s late delivery of the crankshaft to the manufacturer, including loss of profits. The English court found that the plaintiff could recover all the losses arising from the breach that were foreseeable when the parties entered into the contract. This basic rule—that the nonbreaching party can recover foreseeable damages arising from the breach—survives today. This case and its basic precepts should inform how we treat both limitations of liability and indemnification.
Limitations of Liability
A limitation of liability is simply an attempt by one party to reduce its financial exposure to the other party if something goes wrong in a business transaction. In the sample contract provision quoted above, the limitation of liability is “neither Party shall be liable to the other Party for any consequential, incidental, or punitive damages, or for loss of profit and, in any event, each party is liable to the other party for no more than $100,000.”
Before we analyze the legal meaning of this provision, let us review a couple of fundamental business principles, based in fairness, that should put the in-house lawyer’s legal analysis into context:
- The seller should stand behind its goods and services. If the seller promises to deliver, and cannot, the seller should be responsible for the proven consequences of that failure.
- The seller is in the best position to manage the risk arising from its goods and services. The seller knows its industry and clients and has the greatest incentive to manage the risks arising from its business. Inserting a limitation of liability into the contract shifts the risk of loss to the buyer, who is almost always in an inferior position to manage it.
Even those who agree with these principles often defend limitations of liability on a few different grounds. One familiar refrain of sellers’ lawyers is that the goods or services to be provided are either low in value or not very profitable. The seller is, in essence, correlating price or profit with risk. As we all know, however, those two concepts are not necessarily correlated. Cheap or low-profit goods or services can create enormous financial risks to the buyer, and expensive or high-profit goods and services can create limited or no financial risk to the buyer.
Another frequently invoked defense of limitations of liability is that the seller does not know what the buyer is going to do with the goods or services. If the seller really does not know what the buyer is going to do with the goods or services (which most often is not the case), a simple solution to this problem is to ask. Practically speaking, for the vast majority of goods and services that a buyer buys, the buyer will modify, adapt, improve, inspect, and engage in any number of activities that would either eliminate or dramatically reduce the risk that the seller is the proximate cause of the loss.
These traditional arguments in support of a limitation of liability are further weakened by the realities of the laws of evidence. As anyone who has ever pursued a breach of contract claim knows, damages are notoriously difficult to prove. A buyer may assert that the seller’s breach resulted in lost sales, lost profits, diminution of brand equity, etc., but is there evidence to prove those losses? A seller has a broad array of counterarguments to any assertion of damages caused by breach, and getting past accusations and allegations often subjects the buyer to complex, time-consuming, and expensive endeavors like hiring economists and forensic accountants and analyzing years of sales data.
Now that we have explored these basic business principles, why limitations of liability contravene them, and why conventional arguments in support of limitations of liability are weak, let us explore the specifics of the limitation of liability clause quoted above. This limitation of liability includes two components: (1) a category exclusion (consequential, incidental, punitive, loss of profit); and (2) a financial cap on nonexcluded damages ($100,000).
For the sake of argument, assume that “punitive damages” and “loss of profit” are clear. Let us examine the two ambiguous category exclusions in this clause: “consequential” and “incidental.” Black’s Law Dictionary defines “consequential damages” as “losses that do not flow directly and immediately from an injurious act, but that result indirectly from the act.” Huh? “Flow directly and immediately” is no less ambiguous than “consequential.” Black’s Law Dictionary defines “incidental damages” as “losses reasonably associated with or related to actual damages” and defines “actual damages” as “damages that repay actual losses.” Again, these definitions are just as ambiguous and circular as the terms themselves.
The ambiguity of these terms reminds us that limitations of liability are not about fairness, but about one party to a transaction trying to assert leverage over the other party. If the party with superior leverage wants to exercise that leverage, there is a more business-friendly way to do so than the conventional limitation of liability clause (like the one quoted above): eliminate all damage category exclusions in the limitation of liability provision (like consequential and indirect) and establish a financial cap (see Ken Adams, Excluding Consequential Damages Is a Bad Idea (Feb. 15, 2010), http://www.adamsdrafting.com/excluding-consequential-damages-is-a-bad-idea/). For example, “Neither party is liable to the other party for breach of contract for the amount of damages in excess of $20 million.”
The benefit of this kind of limitation of liability is that it clearly limits the financial exposure of the breaching party without the ambiguity inherent in categories of damages. After all, a business does not really care if you call a loss “consequential,” “indirect,” or “a giraffe”; what matters is the actual loss it must pay. In addition, if the nonbreaching party has evidence and can prove that the breach caused the loss (a big if), then the nonbreaching party should be able to recover.
In summary, there is no principled defense for a limitation of liability clause. A limitation of liability clause is simply one party trying to exercise business leverage over the other party by shifting the risk of loss. As discussed above, the principles of causation and the laws of evidence and damages have been limiting the financial liability of the party who breached the contract for at least the last 161 years in common law jurisdictions.
Unlike some of the damages category exclusions discussed above (like “consequential” and “incidental”), “indemnification” has a relatively straightforward definition. According to Black’s Law Dictionary, the verb “to indemnify” means “to reimburse (another) for a loss suffered because of a third party’s act or default.” The problem with indemnification provisions is not that indemnification as a concept is unfair or ambiguous, but that indemnification provisions are often long, complicated, duplicative, and, in many cases, completely unnecessary.
The contract clause quoted above is a perfect case in point. Let us begin with what each party is indemnifying the other party against: all claims, expenses, losses, damages, and costs resulting from: (1) breach of contract; (2) negligence; (3) fraud, dishonesty, or misrepresentation; and (4) loss of property, injury, and death arising from breach, negligence, fraud, dishonesty, or misrepresentation. Before a party can seek indemnification from the other party, it must prove that one of the first three conditions has occurred. The problem for the party seeking indemnification is that each of these three conditions is a legal conclusion. One party can allege breach, negligence, or fraud, but that does not make it so. If the buyer sends a demand for indemnification from the seller for negligence, for example, the seller’s lawyer would logically counter that, once the buyer has established that the seller had a legal duty, did not exercise reasonable care, was the actual or proximate cause, and the act or omission resulted in damages, the buyer is entitled to damages. In other words, prove negligence, and the seller will indemnify the buyer. The seller in this case would have the same right through a negligence claim, irrespective of a contract, even without the indemnification clause.
The same logic applies to indemnification for both category 1 (breach of contract) and category 3 (fraud, dishonesty, or misrepresentation). Both of these are legal conclusions, so why would a party reimburse the other for losses until those conclusions are proven? For the party seeking indemnification here, the clause does not have any real benefit—that party still has breach of contract claim and a fraud or misrepresentation claim under tort law.
It is important to note that, although many indemnification clauses mimic the structure analyzed above, not all do. Depending on the phrasing of the clause, or the jurisdiction that governs the agreement, an indemnification clause could make sense. For example, a buyer who is indemnified for the “claims of third parties related to intellectual property ownership of any part of the goods and services” by the seller could make sense, depending on the context. Another often-cited reason for indemnities is that, in some jurisdictions, they allow the indemnitee to collect attorney fees. In some jurisdictions (like the United Kingdom), an explicit indemnification clause may extend the statute of limitations on claims.
However, for each of these justifications, there is a simpler and more direct way to achieve these benefits. Want to collect attorney fees? Include an attorney fee provision. Want protection against a third-party claim? Include an obligation of the other party to ensure that your client is not subjected to such a claim. If your client is subjected to a claim, that is a breach of contract, and all losses arising from the breach are recoverable. Want to extend the statute of limitations on claims? Agree to a period within which the claim must be made in the contract.
The point here is that, like all contract provisions, indemnification provisions should only be used when its utility is clearly understood. In the majority of commercial contracts, it is unnecessary and, given the general contentiousness of these clauses in negotiations, wasteful.
The utility of insurance provisions seems unquestioned. The logic is that having an insurance clause in a contract gives the party seeking the clause additional protection in case something goes wrong. More careful review of the logic and common commercial practice, however, reveals that this conventional wisdom is a myth.
Let us begin with what insurance really is. Insurance is a financial backstop that may be able to pay in case the responsible party cannot. Therefore, unless the insurer is more creditworthy than the counterparty, there is not much logic to requiring the counterparty to carry insurance. In fact, many companies are more creditworthy than the insurers who are supposed to stand behind them. The 2008 financial crisis and the travails of large insurers like AIG are a perfect case in point.
Rather than focusing on what types of insurance the counterparty should have, and the amounts covered, the parties should focus on drafting clear rights and obligations. If one party breaches the contract, the other party is liable, per the general rule of contract damages articulated in Hadley v. Baxendale. How those damages are paid is not the nonbreaching party’s issue and, unless the counterparty is not creditworthy, should not be a real concern.
For argument’s sake, however, let us assume that the counterparty has a poor credit rating and your client is concerned that, if there is a breach of contract (or the other party commits a tort), it will not be able to pay. Then insurance might be good protection, right? Well, maybe. If the loss is covered by the counterparty’s insurance and if the counterparty is paying their insurance premiums on time, then, yes, insurance may be a good risk-management tool. However, the insurance clause quoted above (and every insurance clause that I have ever seen) does not help drive this outcome.
What would help drive this positive outcome with insurance is if the party seeking protection could both review the counterparty’s insurance contract and confirm that each premium is paid. In the first place, very few parties are willing to let another party review their insurance policies. Secondly, very few parties who would ultimately benefit from the other party’s insurance have the time or expertise to analyze those policies. Additionally, the risks covered by insurance related to categories do not neatly align with the contractual rights and obligations. Although a contractual obligation may be very clear, the facts surrounding the damages may trigger a policy exclusion clause not contemplated by the parties when they entered into the agreement. Most damning is that the insurance clause only serves one practical purpose—it establishes a breach of contract claim if the counterparty does not take out the required insurance. As a practical matter, this does not happen. By the time a party is examining the insurance clause, it is either because the other party has already breached the contract or committed a tort.
Despite this logic, however, contract professionals spend countless hours arguing about types of insurance and appropriate limits, determining what price increases to the goods or services are necessary so that the other party can get the required insurance, and trying to forecast worst-case scenarios. There are many justifications for this behavior, but none are persuasive. One common justification is that, by including the provision in the contract, it will remind the counterparty to procure the right insurance. Unless the behavior is confirmed (by verifying the policy content and that premiums are paid), however, the reminder has little value. As we all know, a certificate of insurance does not affirm the actual content of the insurance or give assurance that future premiums will be paid.
When I remember the Moroccan souk and why negotiation and haggling are so commonplace there, it strikes me that the primary reason for the behavior is cultural. In Moroccan culture, bargaining is a way of life. When I think about why so much waste is generated by limitations of liability, indemnification, and insurance, I come to a similar conclusion—it must be cultural. It may be that these clauses are so ingrained into lawyer nomenclature and templates that contract professionals assume they must add value. Alternatively, it may be that, even if one cannot articulate the exact benefit of the clauses, the lawyer would rather err on the safe side by leaving them in than risk taking them out. However, the point of this article is that these clauses often unnecessarily complicate and slow down business negotiations and should be used only when a lawyer can clearly articulate why they are necessary. Using this standard, in the vast majority of cases, the best option is to eliminate limitations of liability, indemnification, and insurance provisions from your commercial contract.
II. Data, Contracts and Making Hard Decisions – Changing the Way We Manage Business Risk.
Section I is about making contract negotiations more efficient by changing the way we approach 3 notoriously difficult provisions – limitations of liability, indemnity clauses, and insurance. While addressing these issues as suggested would lead to better results, a more fundamental question is why are we devoting substantial resources to negotiating and managing contracts? Contracts are an expensive and inefficient way to manage business risk. Section II focuses on a better way to assess and manage business risk, through systematic and methodical assessment, using data collection, analysis, and various pragmatic risk management tools.
The Current State of Affairs
The amount of time and resources devoted to contracts in the in-house legal environment is truly remarkable. In addition to in-house lawyers and legal work contracted out to law firms, many companies employ devoted “contract management” teams to help draft, negotiate, review, and organize the deluge of contracts that are used in the modern business environment. Despite the many resources that are devoted to the contract generation and maintenance process, the demand continues to outstrip the capacity of those resources.
Sophisticated companies have pursued a number of avenues to stem the tide: adopting standards for contract drafting, using contract automation software, adopting contract lifecycle management technology, and applying LEAN manufacturing principles to legal departments, to name just a few. However, few (if any) companies have questioned why we are devoting such time and resources to contracts, and whether there is a better way.
There is indeed a better way, but to understand how to improve the status quo regarding contracts, we must understand what contracts are, what they do, and what impact they have on businesses.
What Is a Contract and What Does It Do?
If you ask those questions to 100 different contract professionals, you will get 100 different answers. In fact, law school trains lawyers to have an armory of responses to that question, such as “a bargained-for exchange” or “offer + acceptance + consideration.” Black’s Law Dictionary offers seven different definitions of the term, accompanied by 32 subdefinitions of specific types of contracts. Although the term “contract” means different things in different contexts, this article focuses on the typed, signed document that memorializes a business agreement (excluding conversations, e-mails, purchase orders, and other communication that may be considered part of the contract).
Fundamentally, this typed, signed contract is a risk-management tool because each of its provisions tries to manage specific risks related to the transaction. Conventional wisdom says that contracts help to manage risk by having the parties agree on their respective rights and obligations, thereby minimizing the risk of disputes if something goes wrong.
Contracts are just one of the many risk-management tools at a company’s disposal. In fact, almost every department or function in a business has a risk-management responsibility and a set of tools to help accomplish this responsibility. For example, credit departments evaluate the creditworthiness of counterparties using Dunn & Bradstreet reports; procurement and corporate responsibility departments evaluate vendor sourcing standards and audit them through recognized third-party auditors; and insurance departments negotiate insurance policies to cover certain business-related losses. In many companies, these risk-management tools are constantly evaluated to determine their effectiveness, often using cost-benefit analysis. Interestingly, companies rarely (if ever) employ such a rigorous and methodical approach to evaluating the utility of contracts as a risk-management tool.
In searching for a cost-benefit analysis of contracts, I found some data on several large, publicly traded, international companies. These companies each reported on material legal issues affecting their businesses. For each of these companies, less than 10 percent of their reported material legal issues (both in number of claims and financial exposure) arose out of, or could have reasonably been prevented by using, a contract. The remaining 90+ percent of material legal issues were unrelated to contracting (e.g., consumer class actions, government tax cases, regulatory issues, product recalls, to name just a few). With these companies, contracts were not the source of their legal headaches.
One response to this might be that contracts were not legal headaches for these companies because their contracts successfully minimized ambiguity and risk. Personal experience suggests otherwise. Many of my former clients in marketing, procurement, and supply-chain functions whose responsibilities require investing a lot of time in contract negotiations have asserted that they have never or almost never referred to a contract to solve a business problem with a third party. Business problems with counterparties are almost always negotiated and, at best, the contract is a starting point for the negotiation.
In today’s business world, relationships are decreasingly transactional and more often oriented to sustainability and long-term value. That trend is evidenced by initiatives like supplier relationship management and development and co-innovation. Most companies rely on their counterparties for more than a single transaction, meaning that there is little chance a contract will be litigated, mediated, or subject to arbitration. In addition, the risk-management protection that contracts afford is recourse-oriented rather than preventative. In the unlikely event that a contract is litigated, mediated, or subject to arbitration, the damage is already done—a business has already experienced a loss and whatever can be recovered through these dispute-resolution processes is likely to be much less than the losses the company actually suffers. In this context, using a contract as a primary risk-management and dispute-resolution tool is often counterproductive, expensive, and ineffective.
That is not to say that contracts do not have a purpose—they do. If done well, a business contract provides clarity and can facilitate business relationships. However, that is a very big “if.” As the International Association for Contract & Commercial Management (IACCM) statistics consistently show, contract professionals spend a disproportionate amount of time attending to value-destroying issues rather than those they believe are really important. In addition, as legal writer Ken Adams has persuasively argued, conventional contract drafting is notoriously ambiguous, duplicative, antiquated, and confusing (see A Manual of Style for Contract Drafting, Ken Adams, Introduction, xxx-xxxi). One solution is to wait until a critical mass of lawyers adopts a rigorous set of contract-drafting parameters (such as Adam’s A Manual of Style for Contract Drafting). Given the nature of lawyers and the history of our profession, I am not holding my breath. A better way is to systemically reduce the importance businesses assign to contracts in favor of robust risk assessments and pragmatic risk-management strategies.
The Basics of Risk Assessment
As stated earlier, a contract is a risk-management tool. Whether a company should use a contract or another of the myriad risk-management tools available should be determined after performing a proper risk assessment. Here is how a standardized risk assessment might work: A project leader for the transaction is selected. The project leader is responsible for completing a standard form chart with five columns, based on available data and using the input of the company’s subject-matter experts. Column 1 lists categories of risks for that business deal. That column could include categories like “Product Safety” or “Creditworthiness of Counterparty.” Of course, the anticipated risks vary from deal to deal, so the project leader would have the autonomy to list categories of risks as appropriate. Column 2 is labeled “Detailed Description of Risks,” allowing the project leader to describe the particular product safety (or other) risk of that transaction. Column 3 is labeled “Likelihood of Adverse Event,” with a drop-down list of options available, like “High,” “Medium,” or “Low” to be assigned for each category of risk. Column 4 is labeled “Potential Financial Impact” to the company, and Column 5 is labeled “Potential Reputational Impact” to the company, each with a similar drop-down list of options. Here is what such a risk assessment would look like:
When completed properly, this tool effectively gives the project leader a heat map of risks for the transaction, allowing the team to tailor risk-management strategies accordingly. Assume, for example, that the project leader (along with his or her colleagues in corporate finance) deems the “Creditworthiness” risk of the counterparty to be “High” across the board for “Likelihood of Adverse Event,” “Potential Financial Impact,” and “Potential Reputational Impact.” One risk-management strategy is to have a clear contract governing the transaction that includes financial covenants, an insurance provision, and audit rights. However, a more robust risk-management strategy might be to require audited or verified financial statements to be delivered on a regular basis, with the project manager using an internal company resource to verify the validity of those reports. That strategy could be coupled with other risk-management strategies, such as formulating a plan with public relations/corporate affairs to address the “Potential Reputational Impact” if the adverse event occurs, or obtaining a letter of credit from a bank to mitigate the “Potential Financial Impact” of an adverse event.
This kind of risk-assessment tool could be valuable in helping clients judiciously use contracts and eliminating those rigid standards for when to use contracts that currently plague companies. Those rigid and imprecise standards take forms like minimum payment thresholds (must have a contract for any deal where more than $10,000 is paid) and category requirements (any deal related to intellectual property must have a written contract). Risk is not correlated with amounts paid or -the kind of assets or services involved in the deal—cheap goods and services are sometimes risky, whereas transactions for expensive goods and services often are not. Similarly, a business deal that includes IP with a counterparty whose business model does not rely on IP is extremely unlikely to dispute IP ownership. These examples demonstrate the waste created by the rigid standards that currently predominate.
One potential objection to performing such a risk assessment is that some might regard the process as additional bureaucratic red tape. As stated earlier, however, all functions in a business are already (either formally or informally) performing risk assessments and employing risk-management tools. Using a standard process and form for every business transaction actually makes the process more efficient and consistent and gives the company better data for future risk assessments.
Limitations of a Basic Risk Assessment and How to Improve It
Companies could greatly improve their risk management by using a simple risk-assessment tool like the one described above. The success of that tool relies heavily on the project manager, however, and his or her assessment of risk. Yes, that project manager should consult with subject-matter experts in functions like finance, legal, and insurance. Yet, even those companies who select conscientious project managers and institute standards are still reliant on the subjective evaluations of those people. Those subjective evaluations are important, but they are even more powerful when coupled with good, reliable data. Let us use an example to illustrate:
Suppose that there is an anticipated global shortage of a commodity that is essential to a business. The company’s CEO reads about the anticipated commodity shortage in the newspaper and appoints his or her supply-chain leader as the project manager for ensuring supply of that commodity. The supply-chain leader performs the risk assessment and, based on the newspaper articles and the CEO’s statement, deems the “Risk of Adverse Event” to be “High.” Because of that determination, the company employs a host of expensive risk-management strategies, such as stockpiling the commodity at high prices, limiting its commitment to sell end products made with the commodity to customers, and negotiating a new supply contract with its primary vendor. As part of the new contract negotiation, the vendor insists on its standard force majeure clause, which would protect the vendor if the shortage occurs. The company’s attorney objects, leading to a contentious, protracted negotiation and no signed contract.
Now suppose those same facts, except that this time the company has good data related to its past sales activity during similar commodity shortages and the vendor’s activities during those shortages. That data reveal that the vendor has fairly and equally distributed its available inventories of the commodity during past shortages to all of its customers, as opposed to supplying some customers rather than others. Additionally, the company’s historical data reveal that similar commodity shortages have had only a minor impact on its sales while increasing product margin. The company lawyer again resists the vendor’s standard force majeure clause because of the impact that clause might have on the company if the shortage occurs.
Of course, when given this data in context, a CEO likely would not pursue the expensive risk-management strategies of stockpiling supplies and limiting sales contracts. However, I wonder how many CEOs would rein in an overzealous lawyer who fought the vendor’s insistence on its standard force majeure clause. In this context, the force majeure clause negotiation should be evaluated with the same cost-benefit analysis applied to the other risk-management options considered by the company. Given the resources required to fight the clause, the delay in signing a contract, and the contentiousness involved, a cost-benefit analysis based on that data would likely result in a calculated risk to accept the vendor’s standard clause.
Cost-Benefit for Contracts
One reason that cost-benefit analyses are rarely used in determining whether a contract (or a contract provision) should be used is the dearth of contract-related data. Most of the contract-related data generally available today (such as the IACCM’s data mentioned above and in my previous article, “The Moroccan Souk and Your Commercial Contract Headaches”) rely on responses from disparate sources and is insufficient to allow a particular company to perform a refined cost-benefit analysis for a particular deal.
The kind of data that would be more beneficial is more granular data based on industry or particular company experience. In the example above, the valuable data were past behavior and experience of the vendor and the company in similar circumstances.
Companies that are collecting data must ensure that it is used not just for sales projections and marketing campaigns, but for risk assessment and risk management as well. Companies that are not collecting data that can be utilized for these purposes must start, or they risk miring themselves in a cycle of speculative “what ifs” and worst-case scenarios that create significant waste.
Even for companies that consistently and methodically assess risk based on reliable data, someone must make the determination of which risk-management tools are appropriate for the transaction. In most companies, the determination of whether to use a contract is left to the lawyers. Although that delegation makes some intuitive sense, it is often not in the best interest of the company to do so.
A more effective way to manage risk is to allow the project manager to decide which tools are most likely to work, rather than deferring to the subject-matter expert (e.g., legal, finance/credit, or insurance). The project manager has the best overall perspective on the deal and is in the best position to combine various cross-functional, risk-management strategies. Think back to the example of the commodity vendor who once went bankrupt: it is the project manager who can gather the expertise of the credit/finance department, the insurance group, and the legal department to create a risk-management approach that utilizes the best of all available resources. In my experience, project managers are extremely reluctant to make determinations that touch any legal-related issue, but that aversion is generally unwarranted. Risk is risk, and the distinction between legal risks and other risks is often overstated. Ultimately, the consequence of realizing a risk is lost money or liberty, and that is true of every risk a business takes.
III. What’s Making Lawyers Unsatisfied, and How to Fix It.
Sections I and II above take a critical look at a fundamental tool of the business lawyer – the contract. Those sections argue that business lawyers often focus on the wrong issues, and assign too much value to the contract. However, even if the recommendations offered in Sections I and II are followed, that alone is unlikely to make lawyers more satisfied. If we really want to improve performance, we need to shift our focus from a data and process oriented analysis to a more philosophical, humanistic understanding of what motivates business lawyers. As this section will argue, that approach will deliver better results than solely applying the tactical, data and process oriented analysis advocated in Sections I and II.
We know that many business lawyers are generally unsatisfied with their work, either through personal experience or the volumes of headlines, reports, and data that scream that conclusion to us: Unhappiest Job in America? Take a Guess, Why Are So Many Lawyers Are Unhappy With Their Jobs, Why Most Attorneys Are Unhappy. These headlines and the data that underlie them are not new, and despite the many resources our profession has devoted to addressing the problem, it persists. I believe that there is a better way to combat this problem than the traditional remedies, and that is by helping lawyers understand what motivates us professionally, and by helping each lawyer form a plan that provides the best opportunity to realize those motivators. This article shows business lawyers how to create a plan that helps us work toward what motivates us, which will improve lawyer satisfaction and performance as well as generate enormous saving and efficiencies for companies and law firms.
What Motivates Lawyers?
Daniel Pink’s 2010 book, Drive, offers a compelling argument that there is a disconnect between conventional wisdom about what motivates people and what the science and data show. Pink’s central argument is that, for creative professions like the law, financial rewards do not correlate with better performance and professional satisfaction. Pink persuasively argues that better performance and professional satisfaction are correlated with autonomy, mastery, and purpose, and that those businesses that have recognized and applied the science behind these conclusions have generated remarkable improvements to business performance and realized tremendous cost savings and efficiencies. Pink’s analysis helps us understand what motivates lawyers and, through the science and business cases described in the book, gives us a foundation for devising plans that can help lawyers work toward what motivates them. Let us begin by looking at one of our core motivators—autonomy—and how we can apply the lessons of science and business to our profession.
According to Pink, autonomy is “behaving with a sense of volition or choice” and is comprised of four key elements: time, task, technique, and team. At this point, a skeptical lawyer might question whether autonomy is a realistic objective for our profession. After all, we serve a client—how can we be autonomous? However, what Pink means by autonomous is “not the rugged, go-it-alone, rely-on-nobody individualism of the American cowboy. It means acting with choice—which means we can both be autonomous and happily interdependent with others.” Autonomy does not mean that we act independently of our clients, but that we serve our clients in a way that gives us some choice about how we perform that duty.
The first essential element of autonomy is time. It is widely believed that lawyers have little or no autonomy over their time. Whether in-house or at a law firm, the client, the billing partner, or the general counsel needs you to meet a deadline. However, time autonomy is not about eradicating deadlines; it is about how you meet that deadline and how you are compensated for doing so.
The law firm business model is based on compensating lawyers for lawyer input (time) rather than lawyer output (work product). This is the antithesis of time autonomy and a great culprit of lawyer unhappiness. Since the financial crisis, it has become routine to see articles and panel forums commending lawyers for “creative alternative fee arrangements,” although law firm fee structures are rarely creative and usually amount to a discount on hourly rates. In addition, although firms selectively apply alternatives to the billable hour, the law firm business model has not yet changed. It is curious that the billable-hour standard remains, especially given that a viable alternative model has been widely used and refined by the consulting industry for decades. The consulting industry, like business law firms, provides mercenary services to the business world with legions of well-paid associates without sacrificing profits per partner that rival AmLaw 100 firms, and they do it with an output-focused, rather than an input-focused, business model.
Irrespective of why, it is clear that most business lawyers are still captive to the billable hour. So long as the billable hour is a staple of business law firm compensation, we will continue to struggle with giving law firm lawyers autonomy and, therefore, professional satisfaction.
Although time-autonomy restraints for law firm lawyers are more rigid, in-house lawyers also struggle with a lack of time autonomy. In many in-house environments, abiding by the conventional 9 to 5 (or 8 to 6) is expected. In one of my former in-house jobs, it was common to see department leaders strolling the halls at 6:00 p.m. to survey the troops and to hear them criticize department members who took afternoon workouts or who left the office before 5:00 p.m. For legal managers of departments like this, “face time” matters.
Those companies that have experienced success in developing time autonomy for their employees, like Best Buy, take a very different approach. Best Buy eliminated the conventional work schedule which, according to Harvard Business Review, resulted in better relationships, more loyalty to the company, better energy and productivity, and less employee turnover. The point here is that “face time” is not just a waste of time; it destroys value. There is no reason to think that the Best Buy model would not work in a law firm or in a legal department, especially if used in conjunction with task autonomy (described in more detail below).
Another essential element of autonomy as described by Pink is autonomy over task. Companies like Google and 3M give their engineering and technical teams, respectively, 15 percent and 20 percent of their time to devote to any work-related project that the employee wants. These case studies have different implications for in-house legal departments than they do for law firms. At first glance, it might seem impossible for an overburdened in-house legal department to do 15–20 percent less of its traditional workload without negatively impacting the client. However, that same argument is just as true for an engineer at Google or 3M. Most in-house business lawyers have more work than resources and must prioritize accordingly. In the short term, devoting 15–20 percent of a lawyer’s time to a chosen work-related project might jeopardize the bottom 15–20 percent priority of the traditional lawyer workload, but I suspect that the long-term return on investment would be just as dramatic as it has been for engineers, coders, and technical experts at places like Google and 3M. It would be interesting to see what a lawyer would generate with that time, and how such legal experimental doodling might lead to better risk-management for the company or firm.
For a law firm business lawyer, task autonomy is seemingly even more complicated than for the in-house business lawyer. A law firm business lawyer practicing in the billable-hour environment does not really have the choice to find other risk-management solutions to the bottom 15–20 percent priority of his or her workload. However, one potential avenue for giving the conventional law firm business lawyer task autonomy would begin with partner transparency on projects and expected volume of work. Partners would be allowed to schedule a limited amount of work for any single associate (say, 80 percent of that associate’s required hours). The associate would be allowed (and encouraged) to schedule his or her remaining 20 percent on partner-advertised work that the associate finds interesting. Such an experiment would amount to working on task autonomy without time autonomy, and Pink does not speak to what impact achieving one element of autonomy has if others are fulfilled. However, experimenting with one element of autonomy while working toward a larger vision of autonomy is consistent with a spirit of continuous improvement and is preferable to the conventional law firm’s status quo.
Pink’s third essential element of autonomy is technique, or how an employee executes his or her responsibilities. Pink uses several business cases from the customer-service/call-center industry to make the concept real. Zappos.com does not have a supervisor monitoring conversations between service reps and customers, nor does it mandate specific solutions that its employees must give to customer complaints. JetBlue (among others) has added to the Zappos.com approach by letting their customer-service reps handle calls from home, rather than commuting to a drab outpost of cubicles and fluorescent lights. Although these concepts are intriguing, it is the measurable results that impress most: consistently high customer satisfaction and dramatically lower employee turnover, reducing (and sometimes eliminating) recruiting costs.
How to apply technique autonomy to the legal field is less obvious than how time or task autonomy might translate. After all, giving lawyers time autonomy to work when and where they want seems to be the analogy for letting customer-service reps work from home. However, what is impactful to me from the customer-service business cases is not the work-from-home piece, but the freedom that the Zappos.com reps are given to create individual solutions that work under the unique circumstances of each problem. Lawyers often have little autonomy to create a risk-management technique that is appropriate for the circumstances. Too often, legal managers or corporate policy establish absolute parameters that, although provide clarity, do not effectively manage risk in a given circumstance. For example, a written contract for payment of over $100,000 must be reviewed by the legal department and signed by a vice president. Alternatively, the company cannot source a material from a supplier who does not agree to everything in the company’s corporate responsibility code (the drawbacks of these types of rigid standards are explored in my earlier article, “Data, Contracts and Making Hard Decisions – Changing the Way We Manage Risk”). Lawyers must have the autonomy to deliver solutions in a way that is best suited to the circumstances, without micromanagement by their manager, in the same way that the Zappos.com customer-service reps are free to solve customer’s problems.
The fourth and final element of autonomy is team, or allowing an employee to choose with whom he or she works. Applying team autonomy to the legal field is another area that invites lawyers to protest that our field is different from others. Again, clients come to us with their problems, and those clients have often already selected other advisors to help them on the issue. Another barrier to team autonomy is that many lawyers are individualistic, and working on a team does not come naturally. However, those barriers to team building exist for other functions and businesses as well, and yet the successful application of team autonomy has flourished. According to Pink, team autonomy has demonstrated its effectiveness in tandem with the time and task autonomy given by Google, 3M, and smaller companies like Atlassian whose employees pursue their 15–20 percent designated time for self-directed projects with other company employees.
For a legal department attempting to implement team autonomy, the most obvious method is to mimic these models by giving lawyers 15–20 percent designated time for self-directed projects and encouraging them to choose teams to pursue the project’s goals. Those lawyers who like to work on teams must be given the freedom by their managers to form teams for problem solving, either with other lawyers or members of other functions. For the business law firm, there are no other “functions” with which to create teams, but creating cross-specialty project teams can deliver new and promising perspectives to entrenched problems that plague insular practice groups.
The second key component of what motivates us is mastery—the continuous pursuit of getting better at something that matters to an individual. According to Pink, mastery has three laws: (1) mastery is a mindset; (2) mastery is a pain; and (3) mastery is an asymptote. The second law is easy to understand—one cannot master a rewarding endeavor without significant effort. The third law means that no one ever achieves complete mastery, but the way to conceptualize mastery is as an asymptotic arc that gradually approaches a line without ever touching it (mirroring the fact that absolute mastery can never be achieved, but can be approached, first with big jumps then through incremental improvement).
The most interesting of the three laws of mastery, especially for lawyers, is the first law—mastery is a mindset. The scientific basis for this comes from Stanford Professor Carol Dweck, who divides people’s concept of intelligence into two groups: entity theory and incremental theory. Entity theory holds that a person’s intelligence is fixed, whereas incremental theory holds that one’s intelligence is dynamic. For those who conceptualize intelligence by the entity theory, the pursuit of mastery is anathema. For those who conceptualize intelligence by the incremental theory, the pursuit of mastery is elemental and essential.
As lawyers, we see examples of colleagues who, through their behaviors, demonstrate a proclivity toward either the entity theory or incremental theory of intelligence. Entity-theory lawyers believe that our practice is a reflection of innate ability and personality. The entity-theory lawyer believes that evaluation of a lawyer’s quality is subjective and therefore thinks that “mastery” is a concept inapplicable to the work we do. The incremental-theory lawyer believes that, through rigorous logic, modeling, statistics, and data, one can become a better lawyer. The incremental-theory lawyer would identify with the precept that “mastery is a mindset,” knowing that perfection cannot be achieved, but the pursuit of perfection is a tremendous motivator.
When encouraging lawyers to pursue mastery, it is important to understand what type of lawyer is involved. If the lawyer is an entity-theory lawyer, trying to establish a plan for achieving mastery is likely to be fruitless. Mastery is a mindset, and without the right mindset, the effort will be futile. However, if the lawyer is an incremental-theory lawyer, fostering and cultivating a pursuit of mastery will likely pay dividends. Mastery of the law (or any law-related endeavor) is just as elusive as mastery of golf or painting, but establishing clear technical goals, understanding established practices, questioning those practices, consistently tracking one’s progress toward those technical goals, and evaluating the lawyer’s results can be done with lawyers from any practice area.
The final of the three pillars of what motivates us, Pink asserts, is to seek purpose—a cause greater and more enduring than ourselves. Pink cites data showing how both baby boomers and millennials are motivated by more than the basic profit motives and return-on-investment principles that are traditionally associated with corporations. This “more than profit” motivation is not a rejection of capitalism or corporations—it is merely a recognition that deriving noneconomic meaning in what we do is an essential element of the human experience.
Cultivating purpose in a business law environment is tough, especially when many of us have classmates and peers who use their law degrees in ways that are more visibly altruistic or less materialistic. I think that perspective underestimates the value that business lawyers provide to society. As The Economist notes, “Economists have repeatedly found that the better the rule of law, the richer the nation,” and business lawyers are essential to promoting and maintaining the rule of law in commerce. However, the point of this article is not to prove whether business lawyers have a purpose in society, but to determine how to motivate lawyers by orienting them to a defined purpose.
The starting point in helping lawyers to identify their purpose is to ask them. Many of us might respond by listing our job responsibilities or noting our role in supporting a business. A more effective way to help a business lawyer identify his or her purpose is to narrow the scope from the broad role a lawyer plays in supporting a business or an individual lawyer’s job responsibilities to the people who are helped by the work we do. For a law firm business lawyer, that could be a partner or an in-house client. For the in-house business lawyer, that could be a colleague in the finance or marketing department, but I believe that people see purpose in helping other people. That help might be insignificant from the perspective of the lawyer (“I just approved a radio ad—it only took five minutes.”), but if that help is beneficial to the recipient (and the lawyer knows that the work is helpful), our purpose motivator often is satisfied.
The problem for many lawyers is that we rarely get feedback on our contributions and, when we do, it can be inconsistent and haphazard. There are many tools available for obtaining more consistent feedback with better data, but the simplest involves each lawyer establishing objectives with clients, circulating a client survey on a regular basis to monitor progress, evaluating the results, and reorienting and reprioritizing these goals with the client in order to improve.
I know of very few examples of in-house legal departments or law firms that use client surveys in the same way that many other corporate-service functions use stakeholder surveys to monitor performance. This may be because doing so is, at least initially, time and resource intensive. Alternatively, it simply may be an aversion to hearing criticism. I believe that if we are going to consistently give business lawyers purpose, we must collect data and feedback on our work from our clients as part of a consistent, methodical process.
Continuous Improvement Alone Will Not Save Us
Reading Drive got me thinking about what disciplines have used science and data to improve motivation and performance and how commonly that is done in the law. James Suroweicki, in his New Yorker article, “Getting Better at Getting Better,” notes how the application of rigorous science and data, along with a commitment to continuous improvement, has led to a performance revolution in music, sports, and manufacturing. Suroweicki contrasts that performance revolution with the general stagnation of performance in the field of education, which has not adapted the same rigorous approach. Legal writer Ken Adams has said education’s failure to adopt continuous improvement is similar to the legal profession’s resistance to the quality movement, especially contract drafting (http://www.adamsdrafting.com/bringing-kaizen-to-the-contract-process/). In fact, there is a small movement underway to bring the principles of continuous improvement to law, with academics and practitioners writing about how “legal operations,” “LEAN Legal,” statistical models, and rigorous data are going to transform the practice of our profession. Influential Indiana University Professor Bill Henderson has persuasively argued that the economic benefits derived from LEAN processes will dramatically change how large law firms work (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2356330). There are even specialists offering “black belts” and other certifications in LEAN legal and organizations claiming that they can help law firms and legal departments implement those ideas.
The commonality among these proponents of the nascent legal continuous improvement field is their emphasis on finding waste in the legal value chain through rigorous data, logic, statistics, and analysis and using that information to deliver cost savings and efficiencies. This science- and data-driven approach is reminiscent of the revolution in professional baseball in the early 2000s that used and applied advanced metrics and statistics (in baseball parlance, Sabermetrics). The power of Sabermetrics was popularized in the 2011 film, Moneyball, which celebrated Oakland A’s General Manager Billy Beane for outsmarting wealthier teams in larger markets by cleverly applying data and science to maximize player performance.
Interestingly, although fields such as law and education are still trying to harness the power of rigorous data, logic, statistics, and analysis, professional baseball has moved on. Theo Epstein, a famous disciple of Sabermetrics as former general manager for the Boston Red Sox and currently the Chicago Cubs, recently said:
Fifteen years ago there weren’t that many teams specializing in the statistical model to succeed. You could really get an advantage using it. I think the real competitive advantage now is in player development—understanding that your young players are human beings . . . investing in them as people—and helping them progress. And there’s no stat for that. I don’t think everything in baseball—or life—is quantifiable. Sure, if you ignore the stats, if you ignore empiricism, if you ignore objective evidence, then you’re a fool. But if you invest in stats so fully that you’re blind to the fact the game is played by human beings, then you’re just as much of a fool (http://chicago.suntimes.com/sports/theo-epstein-eschews-sabermetrics-for-humanistic-approach/).
Epstein still believes in the power of rigorous data, logic, statistics, and analysis, but he believes that understanding what motivates his players is more important.
A single-minded focus on lawyer efficiency, processes, and cost savings is just as myopic as a baseball GM’s blinded devotion to Sabermetrics. Lawyers need a continuous improvement program that focuses on what motivates them personally, and Daniel Pink has set the foundation for how to accomplish that. All lawyers must understand what autonomy, mastery, and purpose means for them and establish a plan to help them achieve that, all while measuring results and monitoring progress with rigorous data, logic, statistics, and analysis. A well-applied program featuring these elements will have remarkable return on investment through talent retention, improvement in work quality, cost savings, efficiency, and, most importantly, satisfaction.