The Endless Inefficiency of M&A Drafting

You might find of interest The Inefficient Evolution of Merger Agreements, a law-review article by two law-school professors, Robert Anderson and Jeffrey Manns. (You can get a PDF copy here.)

The authors did something that is still relatively novel when it comes to study of contract drafting—they engaged in empirical research. Specifically, they used computer textual analysis to analyze 12,000 public-company merger agreements filed over 20 years. They were able to construct “family trees” of contracts, from which they determined how merger agreements are drafted and how they change over time.

Here how they summarized their findings:

We show that a high level of “editorial churning,” unnecessary and ad hoc edits that appear to be cosmetic rather than substantive, takes place in legal drafting. This churning appears to go far beyond the necessary deal-specific edits, with over half of the text of merger agreements are routinely rewritten even though the substantive provisions of merger agreements have similar features.

We show that public merger agreement terms are not based off a common “form” agreement, but rather are the product of an “evolution” over many generations. This is true even within large law firms, where drafts are based on prior agreements rather than standardized form language. The absence of even firm-specific forms has led to haphazard and inconsistent lawyering as lawyers add significant amounts of extraneous information to each deal and inadvertently retain deal-specific information from prior deals. This fact underscores the inefficiency of current deal drafting processes and undercuts the argument that merger agreements are distinctively crafted (at great expense!) to suit the needs of clients.

We argue that the remarkable heterogeneity of acquisition agreements reflects lawyers’ tendency to use precedents that they are more familiar with or relate to the particular client they are dealing with, rather than those that may be more readily adapted to the transaction at hand. The result is a path dependent process of deal term evolution that thwarts standardization even within firms and leads to systematic inefficiencies in the acquisition agreement drafting process which raises costs and risk to clients.

Now these conclusions won’t come as a surprise to students of M&A drafting—there’s plenty of anecdotal evidence to the same effect. Nevertheless, it’s interesting to have empirical evidence.

But as I pointed out in my review essay of the book The Three and a Half Minute Transaction: Boilerplate and the Limits of Contract Design (here), it’s one thing to have empirical evidence, but the fun part is the conclusions you draw from it. Below are extracts of the article, followed by my own observations.

***

“The high degree of drafting inefficiency suggests the desirability of a transition to greater standardization of acquisition agreements … . Our technique enables drafters to see the edits that have been made over the past few generations of a draft lineage, allowing them to more easily reverse non-standardized text embedded in a precedent document.”

Standardization sounds admirable, but if you’re looking for optimal contracts, it’s not enough. Computer textual analysis will parse what’s in the corpus of contracts, but it can’t tell you what works best. And it can’t improve on what’s in the corpus, which is invariably of suboptimal quality. (See for example this 2013 post about the contract for Jeff Bezo’s acquisition of The Washington Post.) So for optimal contracts, you need humanoids with suitable expertise. That something I’ve discussed a few times on this blog, including in this 2011 post.

***

“A model agreement [such as the ABA’s Model Merger Agreement], no matter how carefully drafted, is not as appealing to practitioners as a negotiated document.”

Leaving aside other sources of inertia, static model contracts such as the ABA’s model contracts themselves contribute to inertia. That’s because customizing standard contracts is a pain. Automated contract creation, with the user creating a customized contract by answering an annotated online questionnaire using Contract Express or something comparable, is way more efficient. Lawyers are more likely to adopt a new way to draft contracts if it makes their lives easier.

***

“Standardization also would reduce barriers to entry to competitors that could erode the market share of leading firms as there is no intellectual property barrier to copying another firm’s merger agreement template.”

There already is effectively no barrier to entry.

***

“The problem appears to be that such form initiatives are generally unsuccessful because lawyers tend not to use the forms. The attorney creating a document under time pressure tends to start with the precedent that is most familiar, rather than the one that is most standardized.”

Again, static forms are a pain to use.

***

“Shaming is a challenging strategy because lawyers are notorious both for their dearth of shame and the zeal with which they point to technicalities to justify their actions. … Either way lawyers are remarkably skilled at externalizing responsibility or coming up with excuses for problems that they dismiss as systemic.”

No argument! In my experience, the M&A establishment has little interest in discussing the suboptimal quality and inefficiency of M&A drafting, let alone doing anything about it. One can attribute that to various factors: the billable hour, the Balkanized power structure of law firms, cognitive dissonance (see this 2013 post), peer pressure (see this recent post), and so on.

***

“The hope is that clients who are repeat players in the M&A context [namely private equity firms or trade associations for the private equity industry] would have the economic incentive and ability to scrutinize their lawyers’ work product and to overcome the self-interest and lack of shame of deal lawyers.”

As the article points out, expecting clients to force law firms to become more efficient is unrealistic. For one thing, legal expenses attributable to drafting are a small part of the cost of M&A deals. And lawyers at private equity firms come from BigLaw so are inured to the inefficient M&A drafting. Yes, a trade association or consortium of some sort might achieve sufficient economies of scale to allow it to break free of the black-hole-like forces of inertia. But that’s an old idea—I wrote about it most recently in this 2013 post—and I’ve seen no sign that anyone is trying to put together such an initiative.

So you’re on your own. Be careful out there.