Standardizing Deal Documents: Expert Discussion
My post last month Measuring the Consistency of Legal Documents reported on pioneering legal document analysis by Kingsley Martin led to an interesting follow-up dialogue about standardizing transactional documents.
Doug Cornelius (Compliance Building blog and DougCornelius.com) posted a public comment on that post. It led to a private e-mail exchange among Doug and Kingsley (www.kiiac.com or e-mail to kingsley dot martin at kiiac dot com). With their permission, I reproduce the e-mail exchange below.
The discussion raises issues similar to ones in my December 2007 post, Dressing the Emperor: Jones Day M&A Lawyers Speak Out, reporting on comments in an article by Jones Day lawyers Robert A. Profusek and Lyle G. Ganske. They observed that lawyers seldom add value to deal-making, that document creation is now a commodity, and reported on “spearheading an initiative to rethink deal documentation.” I don’t know if that initiative has moved forward but I think Kingsley’s approach would facilitate the creation of document standards and give attorneys the tools to rethink their role beyond document drafters and move towards business counselors.
It also relates to the theme of contract simplification that Kenneth A. Adams raises in his article Retooling Your Contract Process for the Downturn (PDF, also in New York Law Journal, 19 Feb 2009). Adams is a legal drafting expert and has long written about contracts and discusses in the article how simplifying contracts can save money. A combination of simplification and consistency would go a long way to improving the process of law practice, lowering costs, and reducing risk.
Here is Doug’s and Kingsley’s e-mail exchange:
Doug’s Comment on Blog Post Measuring the Consistency of Legal Documents
You need to throw out the Interest Rate Swap Agreement. That is a standardized document. Although the financial implications may be complex, the transaction is fairly straightforward. Standardization removes the transaction costs and allows the market to exist. The derivatives market would not exist without this standardization.
You see a similar standardization in residential mortgages. This allowed the RMBS market to exist. Besides the financial failure, a big failure of the CMBS market was not standardizing the document package.
On another note, one of the difficulties of a work product retrieval system for transaction documents is that the words and provisions are very similar. Much of the value of a particular document is the information that is not in the text of the document itself: industry of the transaction, the bargaining strength of the parties, etc.
As a former real estate practitioner, I can tell you that leases and P&S agreements for real estate are very similar. Since you took your collection from EDGAR you are only seeing the biggest and the most highly negotiated of these types of agreements. That may skew the results.
As for merger agreements, I think the existence of EDGAR has changed that practice. You have a big collection of these documents, so everyone can look at these for guidance. The other side is that your collection of merger agreements is for public companies. You may get a bigger spread if there were more private-private merger agreements.
I think the results show the benefit of document automation systems. The majority of provisions in a document do not change from transaction to transaction. A lawyer’s time is better spent on the pieces that distinguish that transaction from others.
Standardization will be good for the legal profession. It reduces transaction costs, which is good for the client. It allows the lawyer to focus on the key issues and language in agreements which should make the lawyer’s practice more interesting.
Doug Follow-Up E-Mail Comment
One of the interesting features for markup is the approach taken by Fannie Mae in their DUS [Desktop Underwriting System] program for multi-family mortgage loans. All changes to the document are in an addendum rather than incorporated into the document. Anyone can quickly see how that document differs from the standard form.
Of course, for a document with lots of changes, it gets very difficult to read. The Fannie Mae documents are very fair to the borrower so there is generally very little negotiation. (As a result, legal fees are low.)
The Rouse Company used to take the addendum approach for their smaller retail leases as well. That worked, not because their lease form was fair, but that they rarely agreed to changes. There was a big imbalance in bargaining power.
Kingsley Replies to Doug’s Comment
Thanks for the feedback.
I included the ISDA document as a yardstick or control, but I do agree that using a standard form is hardly a satisfactory measure of consistency.
I also agree with Doug that one likely direction for transactional documents is a Master Document, configurable through Definitions and/or a term sheet.
Indeed, this is the way the ISDA document works.
We are beginning to see industry groups, such as the IACCM in the US and the ICC in Europe, develop standard documents that can be rapidly drafted and customized with an addendum. Mortgage lenders, for example, have for a long time used riders.
The challenge is still to identify the standard terms and to secure agreement of interested parties. Individual corporations and law firms are starting to create their own standards. Where the effort involves an industry group, the process can take many years, as with ISDA. And in this case, parties to the OTC Derivative contracts are often the same organizations, sometimes on different sides of the deal. In other words, they have a shared interest in conformity and fairness.
Where there are divergent interests, it is likely that the process of standardization will take longer, unless as Doug points out one side can dictate terms. However, one of the goals I seek to achieve is to narrow the points of divergence. Whether it is a loan agreement or an asset purchase agreement there are a few key provisions; the remainder are already fairly consistent, or in some cases inconsistent for really no good commercial reason.
Doug Replies to Kingsley
I found it interesting that the ISDA was not higher. I would have expected 99-100% consistency. Again it could be that that the documents you pulled from EDGAR are highly negotiated for that type of document.
There was some effort to standardize early investment documents from a Silicon Valley legal association. They never got very far.
The one standardization I saw over the last few years was the inter-creditor agreement between a mortgage lender and mezzanine lender in real estate documents. The form was drafted by Dechert as counsel for S&P. Lenders started requiring that form or a comparison to that form in securitized mortgage loan originations. That financing market has now disappeared so I am not sure if the form will stick.
Too many lawyers think of themselves at artisans for these agreements and that they must use their template. Having a common starting point would make the legal work easier on the lawyers and the client. Your study goes a long way toward showing the need to have at least common outline.
Kingsley Replies to Doug
I too thought the ISDA documents would be 100% conforming. I think there are two reasons for this slight discrepancy. First, the ISDA document has gone through two main iterations (1992 and 2002) and the differences between the drafts may be causing the some divergence. Also, I have come across many cases where lawyers have amended some of the language, despite the fact that it is indeed intended to be a standard–some lawyers probably cannot help themselves and make a few edits!
Friends of mine who practice in this area have told me that they have changed from attaching the Master Document, to incorporating it by reference, and more recently they are executing the term sheet as if the Master Document were incorporated. This may be in part to prevent the terms from being edited.
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