I noted with interest the article Lock-Up Creep. It’s by Steven M. Davidoff, the least of whose accomplishments is the fact that he’s my webcast co-presenter, and Christina M. Sautter, of LSU Law Center. The article is in the most recent issue of the Journal of Corporation Law, but currently the best online source for it is SSRN (here).
What are lock-ups? From the article:
Lock-ups are contractual devices that buyers and sellers negotiate in an acquisition agreement. A lock-up theoretically compensates a buyer for its investment costs in making an initial bid for a target by making a second, competing bid more costly. The theory is that without such compensation, an initial bidder would be unwilling to expend its resources to bid, knowing that others might free-ride on the initial bidder’s efforts.
What is “lock-up creep”? Again, from the article:
If you have regularly read merger agreements over the past decade, you may have had a creeping feeling. The number and type of merger agreement lock-ups have materially increased, a phenomenon that this Article terms “lock-up creep.” Not only have new lock-ups arisen, but the terms of these lock-ups have become more varied as attorneys negotiate ever more intricate terms. The result is that the provisions of merger agreements addressing lock-ups now go on for multiple pages and are the main focus of attorney negotiations.
The article considers whether lock-up creep is due to market forces or agency costs. By “agency costs,” the authors are referring to change driven by deal lawyers:
Freed of court restrictions, buy-side lawyers, wanting to show value to their clients, negotiated more intricate and novel lock-ups. Alternatively, it may be that lock-up creep is a function of attorneys acting to protect their own interests.
There is other evidence for this story. The takeover market is a concentrated one where a few law firms dominate. These law firms regularly promote their new and novel lock-up inventions in client memoranda. … In addition, because lawyers tend to be form-driven and market-based, meaning that innovation quickly spreads, the fact of a creeping market has been used to justify these lock-ups in all deals, further perpetuating lock-up creep.
As we have already noted, the result has been that the variance among deals while existent does not appear significant, and any variance is often not based on the deal characteristics but rather the law firm negotiating the transaction.
Here’s the conclusion regarding the cause of lock-up creep:
The evidence thus seems to point to there being a strong measure of lawyer agency costs. The best evidence available is that lock-up creep does not appear to have affected the market, except in certain anecdotal cases, pointing to an agency cost explanation. The rapid spread and promotion of innovation in lock-ups and their trumpeting by law firms appears to jibe with this explanation. In particular, the general but not granular uniformity of lock-ups in transactions mitigates towards a lawyer agency story. The contrary evidence—that lock-ups were a market response or a trade-off for other innovations—does not appear to be as strong.
The authors suggest that broader scrutiny of lock-ups by Delaware courts would be the best way to tackle lock-up creep. When it comes to hard-core M&A deal terms such as lock-ups, I’m an utter dilettante, but I’m not sure that looking to the courts is a solution.
That’s because lock-up creep is just another sign that M&A drafting is free of the sort of constraints that ideally would apply to contract drafting— constraints driven by notions of logic and clarity.
Another example of free-floating lawyer-driven complexity in M&A drafting is the notion of “double materiality,” which I recently wrote about in this post.
I suggest that these problems are at least partly due to the notorious insularity of the M&A bar. I myself have encountered, with important exceptions, a general unwillingness to revisit the conventional wisdom. I’ve discussed this with others, and they’ve had similar experiences.
Given that lock-up creep is simply a symptom of broader dysfunction, I’d have thought that any fix would most likely be market drive. But that would require that law-firm clients shrug off their codependency and insist that law firms bring some efficiency to the M&A drafting process. One obvious way to do that would be to commoditize M&A drafting by implementing a broad-based document-assembly system.