Beyond Winning

by Robert H Mnookin

  Our Example Continued

  Tom and his lawyer are now embroiled in litigation with the Big Apple Hotel. Jennifer continues to make progress before the judge. Discovery is unfolding, and she has found several internal reports indicating that the hotel’s manager knew that employees had a habit of leaving trash in public areas of the hotel, including the loading dock. Jennifer is looking forward to deposing the hotel manager about Tom’s complaints to him. Although she has not found a witness who saw trash on the day in question, Jennifer is confident that she can build a case that the presence of discarded food and trash on the loading dock was a recurring and well-known problem.

  Eventually Jennifer and the insurance company’s attorney begin to negotiate in earnest. Although the hotel raises its initial offer to $10,000, if both lawyers follow the usual script, they may deadlock. Jennifer will express confidence in her client’s case and demand a high settlement figure. By asking for the moon, she hopes to anchor the hotel’s thinking. The insurance company lawyer will shrug his shoulders and say, “Well, we have nothing left to talk about.” Or he might attack Jennifer’s arguments and try to discredit her reasoning. Either side may walk away from the negotiation table, hoping to signal a willingness to fight it out in court.

  Of course, Jennifer could take a different—and more problem-solving—approach. Rather than accept or reject the defense attorney’s offer, Jennifer might have the following conversation:

  JENNIFER: Thank you for your $10,000 offer; we will certainly consider it, although based on what I currently understand about Tom’s case, I don’t think it’s realistic. Rather than counter with a higher demand and haggle, I propose that you and I try to come to some shared understanding of what this case is worth—what the court’s most likely to do if we litigate and the opportunities and risks we each face. If we can’t agree, at least we’ll be able to explain to our clients where our differences are.

  DEFENSE: Well, I told you already, I think this case is worth no more than $10,000 to us.

  JENNIFER: Right, I understand that, but I’d like to know why. I’m sure you’ve thought about all sorts of variables—whether you’ll be found negligent, whether Tom was contributorily negligent, what damages would be, etc.

  DEFENSE: Yes, of course we have. And I’m very confident about that $10,000 number.

  JENNIFER: Well, your assessment may turn out to be right and mine may be wrong, but for now at least I think it would be useful to just get a sense of how we both think about the case.

  What is Jennifer trying to do? She’s trying to negotiate with the defense attorney over the process of their negotiations. She knows that the hotel has arrived at a $10,000 figure somehow, and she signals that she’s willing to listen to their logic even if she doesn’t agree with it. More important, she has framed arriving at convergent expectations about the value of litigation as a shared problem—and has flagged that although they might not converge yet, at least they will be better able to explain their negotiations to their clients if they try to understand where the other side is coming from.

  As the negotiation unfolds, Jennifer may have to make many such process moves. In particular, she may want to propose that Tom and the hotel agree to a limited discovery regime that will save transaction costs. Maybe the two sides can agree to refer the case to a medical expert for a neutral assessment of the value of Tom’s injuries, thereby largely eliminating disagreements about damages, regardless of who is found to have caused them. Through creative process suggestions like these, Jennifer can try to reduce the transaction costs of reaching a settlement.

  For now, imagine that Jennifer explains that she thinks the case is worth $72,000, and she explains the logic that she used to arrive at that number. Tom has incurred $9,000 in medical expenses. In the three months after the accident his business lost $34,000 because he could not work—several of his major clients went elsewhere for service. In total, that makes for $43,000 in actual losses. Jennifer considers an additional $47,000 a conservative estimate of his future medical expenses, pain and suffering, and future harm to his business. She then discounts this total of $90,000 by 20 percent because of her estimate of Tom’s comparative fault.

  While admitting that there’s some chance she could prove that the hotel was negligent, the attorney for the insurance company originally rejects her figure because he thinks that a jury would find that Tom was at least 50 percent responsible. He also doubts Jennifer’s ability to prove future damages to the business now that Tom is back at work. He counters with an offer of $35,000. Jennifer disagrees with his reasoning, but she suggests that there may be ways to bridge the gap or processes through which they could test their conflicting assumptions about how these issues would play out in court.

  Jennifer also wants to introduce the idea of finding value-creating trades outside the immediate scope of the dispute. She might try to do this in a conversation with the insurance company lawyer—after first talking with Tom about what his interests actually are.

  JENNIFER: The other thing I’d like to suggest is that you and I make some time to put this litigation to one side and talk about whether our clients may be able to make some kind of broader deal here. I know that Tom and the hotel have done business together for quite some time, so it would probably be worth talking through their business interests and whether there are things we could do apart from settling this litigation to find ways to make them both money.

  Box 7

  DEFENSE: Well, I’m not sure the hotel’s owners are too pleased with Tom after he started this lawsuit. They’ve been using another laundry service for the last few months.

  JENNIFER: I understand. Still, would you mind setting aside some time to talk about whether they might have any business interests that could lead to some fruitful discussion between them? In fact, it might be useful to set up a four-way meeting.

  DEFENSE: I’m not so sure. Let me talk to my client about it.

  Although the defense attorney is initially skeptical about the idea, Jennifer gently persuades him to allocate some time to talk about interests, resources, and capabilities that might be broader than those immediately implicated by the litigation over Tom’s accident. She acknowledges that they might not find any value-creating trades, but she frames their task as one of exploration and invites the other side to join in.

  At a later meeting, they discuss the parties’ interests that are not immediately apparent from the face of the lawsuit. Jennifer leads the way, consistently encouraging the other lawyer to think broadly about what his client wants. They discuss their clients’ needs and interests.

  Jennifer brings these lists back to Tom, and they discuss some ways in which Tom could imagine meeting the hotel’s needs, and vice versa. Tom is curious about what special laundry needs the hotel has, and also about what cost-cutting measures they are considering. Maybe they would be interested in his idea of bringing laundry services on-site at the big hotels. Jennifer and Tom agree that he should meet with the hotel owner at some point to discuss what trades they could make to turn their dispute into a deal.

  CONCLUSION

  This brief example shows that lawyers and clients have an opportunity to create value in legal dispute resolution. By minimizing transaction costs, lawyers can benefit clients even in a negotiation that focuses narrowly on the expected value of the litigation. And by coming up with trades relating to differences between the parties’ interests, resources, and capabilities, lawyers can turn even seemingly intractable disputes into productive deals. The opportunities are there—but lawyers and clients need to know how to look for them.

  The core of most legal dispute resolution is assessing and shaping both sides’ perceptions of the expected value of proceeding to court. Because the expected value—and each side’s perception of it—is not fixed, the temptation to engage in hard bargaining to seek distributive advantage can be formidable. And lawyers are often quite skilled at hard-bargaining tactics and tricks and may be most comfortable negot
iating in that style.

  This chapter has identified two problems with the status quo. The first is that when both sides hire attack dogs, both sides end up in a bloody mess. Litigation becomes expensive and wasteful, and the parties are unlikely to resolve their differences quickly, cheaply, or in a way that maintains a working relationship. The second problem is that the traditional approach to legal disputes does not provide an opportunity for finding trades that are mutually beneficial. Although not all legal disputes have immense value-creating potential, many do. And if lawyers get stuck in a hard-bargaining mode, they are unlikely to find value where it is available.

  5

  The Challenges of Deal-Making

  Textile Corporation, a manufacturer with worldwide operations, decides to sell an unoccupied brick building that was a mill in the nineteenth century. This property, which is situated next to a stream in the heart of the Berkshires in western Massachusetts, is listed with the local realtor for $3.5 million. David Dirks is interested in buying the building and the surrounding parcel of land in order to convert it into a shopping center. David is betting that the architectural distinction of the building, its beautiful site, and tourist flow into the Berkshires will make this a lucrative investment.

  After viewing the property several times with the listing real estate broker, and after having his architect and contractor examine the site, David meets with Victoria Leigh, a vice-president of Textile Corporation, on July 1. David tells Victoria that he hopes to convert the old factory building into a stylish shopping mall, that he is confident he can secure a mortgage to finance the project, and that he would like to consummate the sale by October 1. After viewing pictures of similar projects David has developed, Victoria expresses approval of David’s plan and offers the support of Textile Corporation, which has a good relationship with town residents and local businesses, in helping David obtain regulatory approval for the project.

  After a few hours of negotiating, David and Victoria agree on a price of $2,985,000. David hands Victoria a $10,000 check and calls it a good-faith deposit. Victoria looks him in the eye, shakes hands, and says, “We have a deal at $2.9 million with an October 1 closing. Have your lawyer send over the formal contract.”

  A DEFINITION OF LEGAL DEAL-MAKING

  In the broadest sense, deals can be defined as economic agreements between two or more parties.1 This definition encompasses virtually all voluntary exchange. It includes transactions over standardized products with fixed prices—like purchasing food at a supermarket, buying a newspaper from a street vendor, or paying for dinner at a restaurant—as well as transfers of more ephemeral or intangible assets, such as a lease, in which a new property right is created, carved up, or allocated. Corporate mergers, home sales, employment contracts, joint ventures, intellectual property licensing, strategic alliances, and long-term supply contracts between manufacturers and distributors are all complex deals.

  For purposes of negotiation, what differentiates deal-making from the resolution of legal disputes? In deal-making, neither party has a preexisting legal claim against the other. The alternative to an agreement is to go elsewhere in the market, not to court. Suppose Ted walks into Anne’s Office Supply and asks how much Anne charges for 8 ½″ × 11″ white paper that can be used in Ted’s ink-jet printer. Anne says a package of 500 sheets costs $9. Ted takes out two twenties and a ten, lays the money on the counter, and asks, “Will you sell me six packages for $50?” If Anne says no, Ted has no legal claim against Anne. He must simply look for another vendor who will accept his offer.

  Suppose Anne says yes, takes Ted’s money, rings up the sale, and gives Ted the six packages. This is what is known as a spot-market transaction: concluded on the spot. Before the exchange takes place—before the time when, literally, Anne accepts the cash and hands over the paper—neither buyer nor seller is legally bound to consummate the sale. As soon as the transaction is complete, Ted owes Anne nothing (he has already paid in full), and Anne has no obligations to sell other office supplies to Ted. But even in this simple deal, the law provides background rules that shape the transaction and impose limits on what the parties can agree to. Law constitutes a framework within which private ordering takes place. For example, although Anne may not have made explicit promises about the paper’s suitability for use with an ink-jet printer, the Uniform Commercial Code may furnish such a warranty.2 Law is thus relevant to deal-making negotiations even when its role may not be immediately obvious.

  Even some transactions creating complex legal obligations are completed without lawyers. Consider an apartment lease negotiation between a landlord and tenant. The property right must be defined with precision—which apartment, how many spaces in the garage, and who has easements burdening the land. A landlord might warrant that the apartment is habitable under state law or promise to make certain repairs before the tenant takes possession. Despite the complexity of these arrangements, parties frequently execute residential leases without the assistance of lawyers. In some states, lawyers are no longer typically involved even in the purchase and sale of residential real estate.

  In this chapter we focus primarily on deal-making in which lawyers are involved in the process of creating legal obligations concerning the exchange or allocation of assets and services between two or more parties. Lawyers tend to become involved in deal-making when the assets to be transferred are idiosyncratic or difficult to define; when the parties make promises or representations that extend over time; and when the value of the parties’ agreement hinges in part on external contingencies, such as securing regulatory approval. More generally, lawyers tend to be involved in deal-making when the risks associated with a transaction are not well known or when there is no standard method for allocating those risks.3

  THE LAWYER’S ROLE IN DEAL-MAKING

  Many deals originate as broad agreements-in-principle, in which clients establish price, delivery dates, and financing arrangements. Two corporate CEOs, for example, may agree to merge their companies, or a borrower and lender may agree on the amount and interest rate of a loan. Lawyers rarely play a central role in this stage of the negotiation, although some clients want their lawyer to be responsible for negotiating everything. In the more typical case, lawyers get involved in deal-making negotiations when the time comes to identify and allocate bundles of risks and to make binding legal commitments to the other party.

  Identifying Risks

  Lawyers typically enter deal-making when the parties want to specify their obligations to each other in precise written terms.4 Lawyers then bear primary responsibility for translating into legally recognizable concepts the parties’ preliminary understanding of their deal.5 In addition, legal drafting involves identifying and allocating ancillary risks that the clients may not have considered but that can have significant distributive consequences.

  David Dirks and Victoria Leigh did not have lawyers present at the time they shook hands on their deal. When each later consults with an attorney, both lawyers will probably ask questions about a range of risks and contingencies, some of which may cause the parties to reconsider the deal’s value. David’s lawyer, for example, might be concerned about whether the property can be used as a shopping center without a zoning variance. Does David want the right to defer the purchase until all zoning requirements are secured? What if it appears that the zoning board will not approve this use of the property? Does he want out of the deal? Similarly, David’s lawyer might wonder about the present condition of the property. Does he want a right to inspect? What happens if the inspection reveals structural defects? Or if David learns that the conversion will be more costly than he originally contemplated? Or if the land is unsuitable for some other reason, such as environmental contamination?

  As the conversation progresses, David’s lawyer will also ask about a variety of smaller, subsidiary issues. For example, what exactly is being sold? Are the old machines and lighting fixtures in the mill included in the purchase price or must the seller re
move them before the closing? David’s lawyer might ask about the dimensions of the property. Without a survey of the land, David may not have an accurate impression of its boundaries. Should the purchase price be reduced if the parcel is smaller than both sides believed? David’s lawyer presumably will continue to ask questions until he feels confident that his client understands what exactly is being purchased.

  David’s lawyer will also be concerned about a variety of things that could go wrong: risks of nature, such as the possibility that a flood or fire may destroy the property before the closing; regulatory risks, such as the possibility that the zoning board will deny a variance; economic risks, such as substantial changes in interest rates. Lawyers often try to anticipate and address these sorts of exogenous contingencies—outside the control of either party.

  There are also endogenous risks, created by the possibility of strategic behavior by the other party.6 Recall the lemons problem. In putting the deal together, Victoria may try to mislead David about the condition of the property if she knows something about it that would be difficult for David to discover. Lawyers seek to design contractual provisions that guard against the lemons problem and make such precontractual opportunism less likely.

  Similarly, in almost every deal in which the parties have a continuing relationship, there will be the potential for moral hazard. The moral hazard problem concerns postcontractual opportunism.7 One person may pursue his private interests at the other’s expense after the contract is signed. Recall, for example, that Victoria suggested that she could help David get any necessary variance from the town’s zoning board and could find prospective tenants. Absent incentives built into the contract, David has little assurance that Victoria will use her best efforts to help him after he buys the property. Victoria could take her money and run. David’s lawyer would want to consider incentives, either positive or negative, to dampen these hazards.