TCS Daily


First, Kill All the Transactional Lawyers?

By Stephen Bainbridge - January 9, 2007 12:00 AM

Transactional lawyers play a critical role in virtually all business transactions. But why is this so? The reason people hire litigators is obvious—either they are being sued or they want to sue somebody else. Unauthorized practice of law statutes and bar admission rules give lawyers a near-total monopoly on litigation. The rationale for hiring transactional lawyers, by contrast, is less obvious. Much of the work of transactional lawyers entails giving advice that could be given by other professionals. Accordingly, it seems fair to ask: why does anybody hire transactional lawyers?

The question is neither an idle nor a rhetorical one. As Ronald Gilson and Bernard Black have observed, business people often have a "quite uncharitable view of what business lawyers do. In an extreme version, business lawyers are perceived as evil sorcerers who use their special skills and professional magic to relieve clients of their possessions."

In his book, The Terrible Truth About Lawyers, Mark H. McCormack, founder of the International Management Group, a major sports and entertainment agency, wrote that "it's the lawyers who: (1) gum up the works; (2) get people mad at each other; (3) make business procedures more expensive than they need to be; and now and then deep-six what had seemed like a perfectly workable arrangement. Accordingly, I would say that the best way to deal with lawyers is not to deal with them at all."

Pretty depressing stuff, especially if you hope to make a living as a transactional lawyer.

Part of the problem is that law schools mainly train their graduates to be litigators. While good litigators typically have good negotiating skills (most lawsuits being settled, after all), there is a fundamental difference between the largely zero sum context of litigation and transactional lawyering.

Successful transactional lawyers build their practice by adding value to their clients' transactions. From this perspective, the education of a transactional lawyer is a matter of learning where the value in a given transaction comes from and how the lawyer might add even more value to the deal.

Two competing hypotheses suggest themselves. The first might be termed the "Pie Division Role." In this version of the transactional lawyer story, lawyers strive to capture value—maximizing their client's gains from the deal. Although there are doubtless pie division situations in transactional practice, this explanation of the lawyer's role is flawed. Pie division assumes a zero sum game in which any gains for one side come from the other side's share. Assume two sophisticated clients with multiple advisers, including competent counsel. Is there any reason to think that one side's lawyer will be able to extract significant gains from the other? No. A homely example may be helpful: You and a friend go out to eat. You decide to share a pizza, so you need to agree on its division. Would you hire somebody to negotiate a division of the pizza? Especially if they were going to take one of your slices as their fee?

The second hypothesis might be termed the "Pie Expansion Role." In this version of the story, people hire transactional lawyers because they add value to the deal. This conception of the lawyer's role rejects the zero sum game mentality. Instead, it claims that the lawyer makes everybody better off by increasing the size of the pie.

The emphasis herein on the pie expansion model is consistent with our concomitant emphasis on transaction costs economics. For the most part, lawyers increase the size of the pie by reducing transaction costs. One way of lowering transaction cost is through regulatory arbitrage. The law frequently provides multiple ways of effecting a given transaction, all of which will have various advantages and disadvantages. By selecting the most advantageous structure for a given transaction, and ensuring that courts and regulators will respect that choice, the transactional lawyer reduces the cost of complying with the law and allows the parties to keep more of their gains.

An example may be helpful. Acme Corporation wants to acquire Ajax, Inc., using stock as the form of consideration to be paid Ajax shareholders. Acme is concerned about the availability of appraisal rights to shareholders of the two corporations. Presumably Acme doesn't care about the legal niceties of doing the deal—Acme just wants to buy Ajax at the lowest possible cost and, by hypothesis, with the minimal possible cash flow. In other words, the client cares about the economic substance of the deal, not the legal form it takes. As Acme's transactional lawyer, you know that corporate law often elevates form over substance—and that the law provides multiple ways of acquiring another company. A solution thus suggests itself: Delaware law only permits shareholders to exercise appraisal rights in connection with mergers. Appraisal rights are not allowed in connection with an acquisition structured as a sale of assets. Hence, while there is no substantive economic difference between an asset sale and a merger, there is a significant legal difference. By selecting one form over another, the transactional lawyer ensures that the deal is done at the lowest possible cost.

Parties would experience some transaction costs even in the absence of regulation, however. Reducing those nonregulatory costs is another function of the transactional lawyer. Information asymmetries are a good example. A corporation selling securities to an investor has considerably greater information about the firm than does the prospective buyer. The wise potential investor knows about this information asymmetry and, as a result, takes precautions. Worse yet, what if the seller lies? Or shades the truth? Or is itself uninformed? The wise investor also knows there is a risk of opportunistic withholding or manipulation of asymmetrically held information. Note that this is a species of the agency cost problem. One response to agency costs is monitoring, which in this context takes the form of investigation—due diligence—by the buyer. Another response to agency costs is bonding by seller, which in this context would take the form of disclosures including representations and warranties. In either case, by finding ways for the seller to credibly convey information to the investor, the transactional lawyer helps eliminate the information asymmetry between them. In turn, a variety of other transaction costs will fall. There is less uncertainty, less opportunity for strategic behavior, and less need to take costly precautions.

All of which is why both legal education and the apprenticeship served by young associates must emphasize not only legal doctrine but also economics and business. It may still be possible for someone lacking any knowledge of finance and economics to be a successful mergers and acquisitions lawyer, but I doubt it. As Mark McCormack observed, "when lawyers try to horn in on the business aspects of a deal, the practical result is usually confusion and wasted time." Transactional lawyers therefore must understand the business, financial, and economic aspects of deals so as to draft workable contracts and disclosure documents, conduct due diligence, or counsel clients on issues that require business savvy as well as knowing the law.


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11 Comments

Real Estate
I purchase two houses out west a without working through a lawyer.

In MA, a lawyer was needed.

That's why I like doing business with Japan!!
The Japanese very seldom, if ever, use this version of an *******.
(All attorneys are assholes by definition!)

Not "needed."
The lawyer in MA was not "needed" --- merely required under MA statutes to protect job security for the assholes. Same in NY.

A Rose by Another Name?
If we didn't use transactional lawyers, we'd use the same folks but call them something else (transactional specialists?).

Last year, I did business without a lawyer--and the contractor used his form agreements to steal the business (over $1M), destroyed hte project (over $10M), and pocketed $250K. It was the last time I'll do business without having an attorney review the documents for me.

Practice of Law- Open Source.
One judge opined that that a definition of the practice of law is neither necessary or desireable (translation: we'll tell you when you're stepping on your toes), rather its those things that a lawyer customarily does (translation: we reserve the right to expand our profession when, how and har far we see fit).

Today, lawyers review railroad operating rules, hospital treatment procedures, military engagement rules and a variety of other documents related to tasks that were "customarily" not subject to legal purview in the past. One acquaintance who served in the Federal Railroad Administration has publicly commented on the excess number of lawyers skilled at wordcraft who knew nothing about the operating practices of railroads. If you care to see their work, try reading 49CFR parts 200-499.

The problem isn't lawyers, its the bar and law schools. Unlike physics, engineering and medicine, the law doesn't condemn one to catastrophe if a practitioner fails to follow a immutable law (such as administering improper care or failing to account for all deforming forces in a structure).

The law has becoming exhausting and complicated because as the Professor points out law schools train litigators. I'll go one further-I don't think we should have law schools at all. The practice of law should be open to anyone who can pass a test and serve an appropriate apprenticeship. Law schools serve two purposes-to make specialists who subject society to ever more precise, ridgid and invasive dictates and conventions and to serve as a "barrier to entry". I'm frankly tired of politicians using law schools, especially the "elite" ones to ensure their offspring have a position of respect, security and authority.

The "law" will continue to erode in respect and esteem until it returns to being something that serves society, rather than something society serves. The curious paradox is that we are often told about how the legal profession provides our freedom, even as it exacts greater and greater fealty from us.













Question
Theres no doubt that he who has himself for a lawyer has a fool for a clent BUT are you sure that the problem of a predator such as this would be stopped by presumably better crafted agreements.

Sometimes people just do what the hell they want, regardless of whats on paper.

In any case, its too damn bad that there's such dishonest and dishonorable folks out there.

mondello senior of oyster bay cove for ******* lawyer of the millenia
Joseph P.Mondello Sr. of Oyster bay Cove LI should be killed for his history of murder, extortion, racketeering, slander and Civil Rights Violations and losing The US Congress 1998 Election for The Republican Party because he did not officially nominate me and gave Greg Becker of Lynbrook the dishonor of losing twice to the unfunded Federal mandate signing pro-abortion and anti-self defense bigot "Catholic Nurse"Carolyn McCarthy. I was only made Nassau County GOP Committee Party Builder for my clean money candidacy, accounting experience, election inspecting experience, human rights experience and health care experience with 87 Lifetime whole Blood and blood platelet donations to The New York Blood Center over my 37 years. As King Henry said "Kill All The Lawyers", and maybe you should include the subversive atty Gary Donoyan of The "Libertarian Party" who continues to censor my posts,and others who have not sent me Federally Certified Bank Checks in accordance with FEC Laws so I can continue providing the leadership as candidate, nominee and elected US President 2008 and 2012 on any available Party Lines in NH and Iowa 2008. Make payable to :Dan Tobin,115 Atlantic Ave Apt 2A,Hempstead,NY 11550-1204

HUHHH!!!
That is a lot of money to be playing with when you don't know what you are doing. Typically a lawyer will help you close loopholes that give advantage to one side. But, using someone elses "standard form" without understanding it is rediculous. I wouldn't enter such an agreement for $1 pack of gum, certainly not for a $10 million project.

A lawyer would certainly have been helpful, but a negotiated agreement, where all parties fully understand their rights and obligations, was the best way to go. In most states you don't need a lawyer for that.

How to kill a great deal....
get lawyers involved. After thirty plus years in the construction business I'll reject any client that comes to me with a lawyer in tow. Nor will I ever again accept a lawyer as a client--experience has taught me better.

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