Beyond Winning

by Robert H Mnookin

  In talking further, the two lawyers explore the possibility of having different severance packages: (1) if Peter is terminated without cause; (2) if he leaves because there is a change in control; and (3) if he leaves because he is not made CEO. Jan suggests that Peter might be willing to accept a shorter period of salary continuation (say, one year) in circumstance 3. Bill accepts this principle and suggests the following compromise: all options vest in each of these situations, with eighteen months’ severance pay if Peter is terminated without cause, one year’s severance if Peter leaves because of a change in control, but no severance pay if someone else is brought in as CEO. The company is concerned about setting a bad precedent for future employees by paying severance because an executive did not get a promotion. Jan agrees to discuss this proposal with Peter, who indicates that it is acceptable.

  RELY ON NORMS

  Jan and Montero West also are able to rely on norms—precedents, rules, or generally accepted ways of doing things—to resolve some of their distributive issues.6 Legal domains vary in the extent to which there are well-structured norms that make it easy to document deals. In some contexts, such as the sale of residential real estate, standardized contracts are widely used and make documentation very quick and easy. In others, the same kind of deal is done over and over—such as a merger and acquisition agreement or a loan agreement. At the other end of the spectrum, some domains are largely norm-free. In new types of deals, for example, there might not yet be a generally accepted method for allocating risks or for correcting particular information asymmetries.

  All of this suggests the importance of learning the norms in a particular context. A lawyer should find out how similar deals have been done before. Better yet, she should find out how her counterpart across the table has negotiated such agreements before.7 Every transaction has its unique aspects, but a business lawyer can’t really proclaim outrage at a particular term when in an identical transaction two months prior he asked for and received the same term himself. Moreover, if one party is reluctant to extend a representation that is common in the marketplace, an adept bargainer may demand recompense, contending that a departure from the norm is likely to unsettle expectations or create inefficiency.8

  In Peter’s case, Jan turns to norms to resolve a variety of distributive issues. Jan and the company’s lawyer disagree about the provisions related to termination in the event of disability. Jan has proposed that if Peter is unable to perform his duties for 180 straight days—six months—then Montero West can terminate him. The company’s lawyer wants 90 consecutive days or any 120 days in an 18-month period. Montero West also proposes that Peter should receive only the payments due him under the company’s disability policy—which would amount to approximately 60 percent of his regular salary. Jan disagrees, arguing that the company should make up the difference between the disability plan and Peter’s regular salary. They also disagree about whether Peter should accrue options and bonuses while on disability leave.

  Eventually Jan turns to norms to resolve this disagreement, which isn’t that important to Peter in the overall framework of the deal. “Here’s one way we could resolve this,” she says. “I’m pretty sure that on this term, Peter would be comfortable accepting whatever disability termination provision is in Henry’s contract. Whatever the company’s giving its CEO seems good enough for the COO as well. Why don’t we just agree that we’ll ask the company to forward each of us a copy of this term from Henry’s executive compensation agreement, and we’ll base our language on that?”

  UNDERSTAND THE LIMITS OF NORMS

  Norms will not dispose of every distributive issue. Often there will be competing norms in the marketplace and parties will have to negotiate over which norm applies. And sometimes one side will dislike the dominant norm and seek to use another norm more favorable to that side. Norms won’t end negotiations by any means. Nevertheless, being prepared to give reasons for what you ask for—to try to persuade the other side through norm-centered argument rather than with pressure tactics—can be helpful.

  A second note of caution about norms: just because a norm exists doesn’t mean that it is efficient and offers the best solution to your particular problem. Like default rules,9 some but not all norms may be efficient. But in a world full of strategic interaction and imperfect information, the use of standardized deal terms may have more to do with copy-catting than with efficiency.10

  Consider a story told to us by an experienced real estate lawyer representing a company that was selling a business in South America. The potential buyer—a large enterprise that frequently buys businesses in Latin America—expressed concern about the possible costs of environmental clean-up. The seller’s lawyer proposed that each side procure an environmental report from an independent expert indicating how much it would cost, if anything, to clean up any environmental hazards. Instead of the seller providing an indemnity to the buyer, the parties could simply reduce the purchase price by the average of the two estimates. If the estimates were more than $100,000 apart, the two experts would pick a third expert, whose determination would be binding. The buyer, however, insisted on getting an indemnity, because “that’s the way things are always done.” The seller’s lawyer even pointed out the risks for the buyer of indemnification—surely if a hazard were later discovered, the seller would have an incentive to defend vigorously against a lawsuit on the indemnity provision, driving up transaction costs for both sides. But the buyer was adamant—and the transaction went through with the indemnity.

  It’s hard to see an efficiency argument for the structure of this transaction, provided the buyer could get detailed and complete information about any possible environmental problems through a report. But the norm prevailed in the end. This story suggests that there may be circumstances in which norms might leave value on the table, even though they ease the distributive issues somewhat. A lawyer’s task is to consider norms within the framework of our basic model of trades based on differences in relative valuations—when a norm stands in the way of a more efficient customized exchange, the lawyers should consider departing from the norm.

  Change the Players to Break an Impasse

  In addition to using norms, deal-making lawyers often change the players to break a distributive impasse. Since ultimately the clients must live with whatever arrangements their attorneys draft, when the going gets tough deal-making lawyers often turn to their clients for help.

  One possible advantage of involving the clients is that it can permit reopening the price term, and this may help resolve distributive issues. Price terms change infrequently in deals because the principals reach an agreement and then turn only the legal matters over to their lawyers. To an economist, this is a puzzle, because the subsequent negotiation between the lawyers often involves the allocation of risks that can significantly impact the overall value of the transaction. Because money terms are generally fungible, we would expect that as the lawyers allocate various risks, the price term would fluctuate as the net present value of the deal changes for each of the parties.

  But it is easy to understand why price terms stay fixed. First, a lawyer may not have the authority to revisit the basic deal terms. Second, the lawyer may feel uncomfortable approaching the client to request that the price term be put back in play. Especially in lawyer-client relationships in which the client is sophisticated and views the lawyer as a scribe rather than advisor, the negotiability of the price term may be difficult to raise.

  Third, revisiting key deal terms can be highly destabilizing to the clients. The principals may both feel that the deal is done, and when one hears through her attorney that the other side wants to reduce the price term, it may feel as though the other side is trying to renege on its word. This is especially so where the principal doesn’t have a good understanding of how important it is to allocate particular risks. The other side may think you are trying to use a nit-picky clause to squeeze more money out of the deal.

  And this can, of cours
e, be true. Still, there are sometimes good reasons to revisit the price term. Doing so can open up a range of trades that might not otherwise be possible if the parties bargained term by term. The price term is a kind of safety valve in the transaction—opening it permits one party to give in on a particular clause in exchange for money when no other kind of trade is feasible.

  Look to the Future: Dispute Resolution Provisions

  No contract covers every issue, risk, or contingency. In joint ventures, leases, partnerships, and custody arrangements, secondary deals are struck at a later date, as unanticipated circumstances arise. In Peter’s case, as in many deals where an on-going relationship is being created, further issues to negotiate will develop over the course of the employment relationship. Against what backdrop will these future negotiations take place? Will the parties be bargaining in the shadow of litigating their disagreements? Or can they create some other dispute resolution mechanism now, in their contract, that will lower the transaction costs of resolving disagreements in these future negotiations?

  Contractual dispute resolution provisions are increasingly common. Often, alternative dispute resolution clauses provide for arbitration under the auspices of a sponsoring agency, such as the American Arbitration Association. The contract might provide this clause, for example:

  ARBITRATION PROVISION: Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by arbitration administered by the American Arbitration Association in accordance with its Commercial Arbitration Rules and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof.

  This provision leaves many issues unanswered. A better provision might make clear that the controversy will be submitted to one arbitrator or to a three-arbitrator panel. In the latter case, each of the parties traditionally chooses one of the arbitrators, and they then select a third neutral to serve as the chair of the panel. If they cannot agree on a third, the AAA might pick that person. In addition, an arbitration clause will provide for notice to the parties, choice of law, and other technical specifics to make any future use of arbitration as smooth as possible. Some contracts provide for a tiered dispute resolution process that begins with mediation and advances to arbitration. The parties are limited only by their creativity.11

  CONCLUSION

  The key thing for attorneys to remember as they try to close deals is that lawyers are only one part of a larger equation. In most complex deals, the clients share responsibility for making the deal work. Many of the most important provisions are dealt with by the clients, not the lawyers. From the clients’ perspective, the attorneys may appear to be negotiating over relatively remote contingencies that have little practical relevance for the deal today. The clients, in short, may not care half as much about the lawyers’ work as the lawyers do.

  This is not to say that lawyers should defer to their clients’ understanding of the importance of various legal provisions nor that lawyers should downplay their own input into the deal-making process. It can simply be helpful to remember that if you can’t win on a given distributive issue or risk, the world probably won’t come to an end. The deal will most likely go through, and your client will most likely be happy. The risk may never materialize, and even if it does, as long as your client has made an informed choice about it, you have done the best you can.

  IV

  SPECIAL ISSUES

  Legal negotiations are complicated. The three tensions present strategic, interpersonal, and agency hurdles to overcome. Deal-making and dispute resolution both implicate the law and force lawyers to bargain in the shadow of the formal legal process. Legal culture introduces often unhelpful assumptions. Psychological biases and emotions can undermine attempts to problem-solve rationally and efficiently. And hard bargaining is always a threat and obstacle.

  In Part III we offered an approach to reorienting your mindset and actions to make it easier to problem-solve even with clients and other lawyers who might not initially share your goals. Before concluding, however, we turn to two special topics that can further complicate legal negotiations: problems of professional ethics (Chapter 11) and multiparty complexities (Chapter 12). These chapters explore ways in which attorneys are both aided and constrained by being members of a profession, a law firm, or a local legal community. Although there could certainly be a long list of other special challenges for negotiating lawyers—including issues of gender, race, and ethnicity and complications arising out of working in very specific legal areas (tax versus litigation, international tax versus corporate tax, and so on)—we focus on these two central areas because of their importance to a broad spectrum of attorneys and the centrality of the negotiation-related questions they raise.

  11

  Professional and Ethical Dilemmas

  When negotiators share material information, particularly information that is costly to verify independently, finding value-creating trades is obviously easier.1 But withholding or manipulating information may confer real distributive advantages. Lying about your best alternative to reaching agreement or exaggerating what you are willing or authorized to accept may influence what the other side will settle for. Similarly, creating bargaining chips by asking for items that are unimportant to you but may be costly to the other side to grant may lead to trades later as you give away these unimportant concessions for more valuable ones.

  Consider the following examples:

  • You are negotiating on behalf of a real estate company to purchase a large apartment complex. Your last offer was $9 million. The seller countered with $11 million. Your client has authorized you to accept this counteroffer if necessary, although they would prefer to pay less if possible. Can you say, “I have authority to pay $10 million and not a penny more” to get the other side to lower the price? Is this legal? Does it violate the codes of professional conduct? Is it ethical?

  • As you negotiate on behalf of your client to settle his divorce, it becomes clear that his spouse is extremely concerned about her two children and does not want to subject them to any more emotional pain in the divorce process than is absolutely necessary. Your client, a well-off business owner, privately confides to you that he is not really interested in physical custody of his children. “But tell her I am,” he says. “I’ve been saying that, too. Let’s push for the kids and scare her, and then at the end we can concede that we won’t have a custody battle if she agrees to end alimony after two years.” Do you demand custody as your client suggests?

  • You are in-house counsel, negotiating to settle litigation against your company. The negotiations are focused on the amount of damages a jury would likely award, because, despite your protestations, liability is clear. As you negotiate, it becomes apparent that the lawyer on the other side has not seen a recent state supreme court opinion opening the door to punitive damages in this context. Do you have an obligation to disclose to the other lawyer the change in the law? Or do you have an obligation to your client to say nothing so as to minimize the amount of the settlement?

  This chapter confronts the ethical challenges raised by common misleading acts or omissions in legal negotiations.2 The issues posed can be assessed from a variety of vantage points:

  • What acts or omissions amount to fraud and are therefore illegal?

  • What are the constraints imposed on a lawyer’s conduct by formal professional codes of ethics?

  These standards together constitute an ethical floor for the conduct of all responsible lawyers. But a conscientious professional will also ask:

  • Even if my behavior is above this floor, is the conduct worth the risk in light of my reputation and other pragmatic interests?

  • Is this conduct consistent with my own moral aspirations?

  Although our primary focus is on the law of fraud and the professional codes of conduct, we keep these four vantage points in mind as we explore the practical complications for lawyers and clients dealing with et
hical dilemmas.

  ETHICS IN LEGAL NEGOTIATIONS

  The most critical ethical issues in negotiation revolve around lies, misleading statements, partial disclosures, and nondisclosures. To understand the ethical implications of these negotiation moves, it helps to see the differences among them.

  The Disclosure Continuum

  At one extreme of the disclosure continuum, a negotiator might lie—intentionally make a false statement about material information in order to trick the other side. At the other extreme, a negotiator voluntarily might disclose all relevant information, regardless of whether the other side similarly discloses. In between, a negotiator may choose not to disclose certain information or may mislead the other side or exaggerate to gain distributive advantage (see Figure 13).

  Imagine that you are selling your car. It runs well but you suspect that something may be seriously wrong because the car has begun burning a quart of oil every five hundred miles. You haven’t had the engine checked and you don’t know how much it would cost to fix the problem, but you fear that a complete engine overhaul may soon be required. What should you disclose to prospective buyers? A seller could voluntarily disclose the oil problem to a buyer and suggest that he have the car inspected. Or a seller might say nothing and hope that the buyer wouldn’t discover the problem. Even silence can be misleading, of course. What if the buyer says, “Gee, the car runs great and doesn’t seem to have any problems at all. I’m looking for something that’s trouble-free.” This buyer may rely upon—and be misled by—your silence.