How Much Deal Risk Can You Tolerate?

I concluded my recent post on “good enough” in contract drafting by distinguishing the quality trade-offs inherent in the notion of “good enough” from the question of how risk-averse you want to be in drafting and negotiating deal terms.

But those issues are related, in that both require you to determine when you reach the point of diminishing returns in allocating resources. In the case of “good enough,” the question is how rigorous in language and substance you want your contract to be, the aim being to enhance clarity and avoid confusion. In the case of risk, the question is whether the protection afforded by covering yourself against a given risk outweighs its drag on competitiveness.

In my “good enough” post I suggested that whereas we may be in a “good enough” world when it comes to technology, that phenomenon is nowhere in evidence in the dysfunction that is mainstream contract drafting. Far from making a calculated decision to sacrific a measure of quality, to all appearances drafters aim to be comprehensive and clear and remain largely oblivious of the extent to which they fall short.

Similarly, drafters could in theory embrace a less risk-averse approach when setting deal terms, with the idea that since much risk only materializes in a small proportion of deals, or doesn’t materialize at all, it doesn’t make sense to burden all deals by protecting against even the more remote risks. But I’ve seen little sign of such a tolerance of risk. In fact, in this post on his Commitment Matters blog, Tim Cummins of the International Association for Contract and Commercial Management notes that a desire to manage risk has contributed to increasing contract complexity. (Thanks to Vickie Pynchon of the Settle It Now Negotiation Blog for sending me a link to Tim’s post.)

The obstacle to a more nuanced assessment of risk in contract drafting is analogous to what makes “good enough” problematic in the context of legal services. It’s all well and good to observe that much risk never materializes, but when you’re working on a new transaction, you’re dealing with the unknown—this might be the deal where a remote-seeming risk materializes. And it’s easy to tell yourself that adding some verbiage to a given set of deal documents is a small price to pay for protecting yourself against potentially disastrous risk—the deleterious effects of undue fear of risk are manifest over the long hual, rather than on a deal-by-deal basis.

There’s no way to get around the fact that you can’t see into the future. But you’re nevertheless going to make some sort of risk assessment—otherwise, you’d document every transaction as if the future of your company were at stake. It would be best if, instead of being handled on an ad hoc, deal-by-deal basis, your assessment of risk and the extent to which you wish to protect against it were based on a clear-eye, big-picture analysis of the costs and benefits.

But talking about risk in the abstract only gets you so far, so here’s a practical suggestion. You won’t be able to handle risk efficiently if you uncritically buy into the conventional wisdom regarding risk-allocation provisions—for example, if you trot out the standard language relating to consequential damages (see this March 2010 blog post), or if you think that it does anyone any good to suggest that best efforts represents a higher standard than reasonable efforts (see this March 2009 blog post).

It’s also tough to handle risk efficiently is you’re employing the clumsy legalese of mainstream drafting—it’s like trying to do dentistry with a rusty screwdriver.

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.

8 thoughts on “How Much Deal Risk Can You Tolerate?”

  1. I tend to think that clients are more risk tolerant than the lawyers that they engage. Of couse, the lawyer will get blamed if things go South. So, almost by necessity, a lawyer will rarely view work product that might be "good enough" for a client as "good enough" to protect his or her own interest. It's a vicious cycle.

    • Melissa: As I noted in my "good enough" post, I think the concept of "good enough" is problematic when it comes to contract drafting.

      And that's particularly the case when you're dealing with industry-wide templates. I'm certainly in favor of the document-assembly approach embraced by AIA and ConsensusDOCs, but the language of their templates is, unfortunately, the same old mediocre stuff.


  2. Ken, I usually describe the risk management approach and lawyering in two ways: first, there's the archetype (or stereotype) of the New York lawyer, who will attempt to uncover every possible ambiguity or alternative and revise it in favor of the client, no matter the transaction costs involved; second, there's the Silicon Valley lawyer who aims to negotiate meaningful terms where documents contain fairly standard language and so the question is more one of operating against a background risk allocation.

    Clearly, neither of these approaches resolves your main point, which is that the connection between the actual drafting and actual risk is part of the problem that is under-appreciated if not denigrated.

    What do you think about the relative quantum of risk from poor/shoddy/misguided drafting and the costs inherent in using litigation to resolve disputes? I'm moving to the conclusion that better deal structure and drafting (and the serious strategic thinking that needs to precede them) is necessary to try to avoid having to go to court at all. Small businesses can't afford to litigate $15,000 problems in the traditional way.

    • Rick: To quote, ahem, Donald Rumsfeld, you have known unknowns and unknown unknowns.

      The first category refers to contract risks that you spot during drafting and negotiating. You're able to assess whether addressing those risks in the contract is worthwhile. This is the category of risk that I mostly had in mind when I wrote this post.

      The second category refers to the risk of disputes that no one spotted. These include disputes that arise due to changed circumstances; there's not much you can do about these other than approach a transaction with a healthy imagination for what might happen down the road.

      They also include disputes due to confusion caused by clumsy drafting. To avoid these disputes, you have to employ clear and modern drafting language. Bear in mind that if you're investing resources to transition from the dysfunction of traditional language, you won't be able to point to a specific ROI in terms of disputes avoided requires resources. But you would be able to point to time saved in not having to wade through bloated, unclear contracts.


  3. Thanks for hat tip Ken! I've been devising a negotiation class for transactional lawyers with a transactional attorney/negotiation professor in Northern California. I was surprised to hear him say that most transactional lawyers don't possess negotiation skills – I always thought of them as the negotiation go-to guys. My new business partner says "no, they're 'write the deal up avoid risk' guys. That put transactional practice in an entirely different light. Do you think, Ken, that transactional attorneys would be better contract drafters if they were more involved in the negotiations leading to the deals they memorialize (or criticize?) My corporate trainings also reveal that the most difficult challenge for in-house attorneys is not their dealings with third parties, but their internal negotiation with the sales force (deal makers) and the in-house lawyers. It was such a surprise to me when I began those trainings to see 80% of Fortune 500 in-house counsel raise their hands in response to the question: "how many of you feel as if you're negotiating from a position of weakness"? The negotiations? Internal. With in-house being seen as roadblock to deal closing. So not surprising they just want to grab a form and not worry about more than a "good enough" contract. As always, thanks for all you do for the profession and for business people.

    • Vickie: I'd flip your scenario: Instead of transactional lawyers becoming better drafters through being involved in negotiations, I suggest that they'd be better negotiators if their drafting were to improve. The urge to draft by regurgitating precedent constrains how you approach a transaction: you end up wanting to make your deal fit your precedent. If drafting were commoditized, lawyers could focus more on devising strategy and negotiating, and much drafting would be turned into a ministerial task.

      And yes, I'm familiar with the sometimes cagey relationship between company lawyers and sales/procurement people.


      • Great thinking! (as always from you). It's the power of the frame – in this case, the imagination limiting framing by a form contract. I'll incorporate this into my trainings. Thanks!


Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.