The combination of technology advances and cost-cutting pressures from clients is triggering a major transformation in the core practices of business law. In particular, the past decade has witnessed the emergence and significant improvement of software that designs, drafts, reads (visualizes and operationalizes), and manages contract documents. These innovations have been disruptive (in the terminology of Harvard Business School Professor Clay Christensen), because they have brought standard transactional services to clients who could not otherwise afford them. To the extent that these new products fall short of meeting the higher-level needs of existing clients of corporate law firms, the products do not threaten the revenue stream of these firms. However, the sophistication and scope of document automation is improving rapidly and the available technology can now significantly reduce the cost of contract negotiation, drafting, and implementation in more complex transactions with client-specific requirements. As the technology moves its way up-market, therefore, it raises an increasingly serious challenge to the business model of corporate law firms.
The standardization of contract provisions has long been a cost-saving practice in transactional legal services. It exploits previously used provisions not only within a law firm but also across the profession and across industries (e.g., standard form swap derivative contracts, shipping contracts, loan agreements). In addition, the modular architecture of contract documents allows contracts to be readily customized to the negotiated, transaction-specific needs of individual clients.1 To a large degree, today’s business contracts are composites of fairly standard modules: representations and warranties, closing conditions, termination rights, remedies, dispute resolution, and so on. Recent technological advances magnify the gains from standardization and modularity. Software for automated document production customizes a given contract by inviting the parties to choose from a menu of alternative standard versions for each module (consider, for example, variations on a material adverse change clause in a corporate acquisition agreement). Automation can also facilitate the reading of a draft document by a counterparty, allowing her to quickly compare each module of the draft against market benchmarks that are derived from collections of contracts in the industry.
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The efficiencies from automation, moreover, accrue beyond the drafting stage and throughout the life cycle of a contract. During the midstream of a contract’s life, its obligations are performed or renegotiated. Software can translate the legal form of a contract into human- and machine-readable (operationalizable) versions, thereby reducing the risk of inadvertent breach or overperformance.2 In addition, digitized contract documents can be efficiently stored and retrieved when changes in the legal or business environment call for adjustments or modification of the initial agreement. Information can also be extracted from stored documents to reveal patterns and risks in the portfolio of contracts of a business entity. Finally, standard and effectively modularized contracts are, all else equal, less likely to give rise to disputes or to costly and uncertain litigation. Indeed, in the foreseeable future, one might imagine the drafting of contracts in machine-readable language that will be susceptible to some type of automated dispute resolution and enforcement.
In sum, automated contract services promise very significant cost reductions at the front-end, midstream, and back-end of contracting. The early development of this technology coincided with the rise of market pressure on legal fees. Heightened competition in many industries has driven corporate clients to cut legal costs and to demand explanations and discounts in legal fees. They are disaggregating services and distributing the component tasks to various low-cost providers, including in-house non-lawyer employees and offshore contractors. The principal focus of attention in the profession and in commentary is on cost: lowering the time and money spent on lawyering transactions. Indeed, corporate clients are prepared to cut costs even if that means accepting less elegant, less tailored, and less complete contract documents. As premium business dissipates, corporate law firms are driven to take on more work at lower rates in order to maintain profitability. A recent cover story in The New Republic reflects the emerging consensus that “[t]here are many, many more high-priced lawyers today than there is high-priced legal work.”3 Even if law firms learn to compete in a world of high- volume, commoditized transactional services, the prospect runs counter to the aspirations of many lawyers.
While the focus has been on cost in the current market environment, much less attention has been paid to the strategy of delivering better products and, particularly, coming up with dramatically superior contract designs (as opposed to gradual improvements in contract drafting). As we pass the 50-year anniversary of the invention of the cassette tape, we can analogize the current focus on cost in legal services to the state of the world we would be in if the personal audio market had been preoccupied with reducing the cost of manufacturing analog portable players rather than developing new generations of digital players, leading to MP3 devices (and beyond). The challenge before the legal profession is to launch a similarly transformative jump in the quality, rather than simply the cost, of legal services. In this essay, I focus on the process (how) rather than the substance (what) of value-creating innovations.
Transactional practice is largely reactive: Lawyers customize contract documents to the requirements of the client in their office. Innovation is a different exercise: Whereas customization is the one-time tailoring of a contract term to a specific transaction and client, innovation is the creation of a new term that can be redeployed in other transactions and standardized. Innovation is proactive: It identifies what the market needs and then develops and markets a new product to serve that need. For some time, the new product sells at a premium over cost, thereby yielding a return on the investment in design. Similarly, by investing in the research and development of novel contract design features, elite lawyers and law firms could exploit new opportunities for premium work while ceding low-end tasks to automation or offshore providers. Although there are a few famous exceptions, such as the development of the poison pill and securitized bundles of mortgage obligations, law firms rarely act proactively to build a premium practice by identifying a market need and marketing a novel solution.4
Innovation in contract design must overcome a number of structural and market obstacles. I will mention three types here (that are more significant than the often cited concern about intellectual property protection).—First, the very standardization and network economies that lead to cost-savings also impede innovation and diffusion of novel provisions. A party that proposes a novel provision in negotiations faces suspicion from its counterparties and, if applicable, in the market for trading such obligations. Judicial interpretation and enforcement is also uncertain. In order to replace and upgrade a standard term, therefore, the innovator must not only invest in designing the novel provision. She must also create channels to diffuse it and thereby shorten the lag between the creation of the term and its broad adoption as a standard.—Second, law firms are not set up to be innovative, at least not in this respect. Organizational obstacles, such as hourly billing and law firm compensation schemes, dampen incentives to invest in the R&D of quality-increasing innovations and promote instead reactive client service.
Even as the profession responds to client pressure by exploring alternatives to hourly billing, however, there is a third, more fundamental obstacle to the sale of premium products. It stems from the nature of transactional services and the difficulty of valuing them. To illustrate, consider how a client might assign a value to the incremental benefit of high-quality contracts over low-quality contracts. At the core of the valuation question is the purpose of a legal contract document. Many commercial relationships succeed without the threat of legal enforcement by relying on the salutary discipline of the parties’ implicit motivation to be fair, their prospect for future dealing, and the importance of their reputation. The value of a contract stems largely from the additional incentive effect of legal enforcement, net of the expected cost of dispute resolution and enforcement. A “better” document, therefore, might be one that fine-tunes incentives by providing for a broader range of contingencies or one that reduces expected costs of dispute resolution. Yet, neither law firms nor clients have the information to calculate the incremental value and therefore cannot reasonably assess whether the clients are getting their money’s worth in a premium contract.5
In light of these structural impediments, how do we, as a profession, shift from the current state of reactive, cost-cutting transactional practice to one of proactive, value-creating entrepreneurship? One potential avenue begins with the observation that lawyers have a tradition of sharing expertise and work products through their common membership in the bar and other organizations. This sharing is partly responsible for the success of market-wide standardization. As previously noted, standardization reduces the cost of contract production but increases the cost of departing from standard contracting language. The modularity of contracts offers a solution to this trade-off. An innovator can improve one provision in a modular contract without the need to adjust other provisions to accommodate the new term. Indeed, many innovators can work at once on different modules of a common contract without the need for explicit collaboration or coordination.
Peer production has realized significant success in knowledge-based industries, particularly in the open-source development of computer software. Surprisingly, open-source collaboration has sometimes provided a more fertile ground for innovation than market conditions of property rights and competition. The widely discussed success of crowdsourcing might be replicated in law if the collaboration within the profession were supported by a platform that would accelerate the process of experimentation, reaction, and adoption of novel contract design and, thereby, overcome the friction created by standardized terms. With this goal in mind, Douglas Barnard and I designed a simple Contracts Wiki prototype several years ago, one that would encourage participants to draft new contract provisions that would address market needs, to edit each other’s proposals, and to comment on them (and even vote between alternatives). The question of why lawyers would participate (and why law firms would allow their employees to do so) raises the same type of doubts as those faced by software companies that ultimately decided to participate in open-source projects. Among other attractions, the opportunity to learn by joining a broad enterprise of professionals, the flexibility to choose where, when, and how one contributes, and the prospect of feedback (and perhaps credit) from peers may be sufficient to overcome the instinctive reluctance to give away the fruits of one’s expertise for free.
The typical architecture of business contracts is largely unchanged since the era preceding the word processor. For many types of transactions, most of today’s contract provisions bear close resemblance to those existing decades ago. Although there are pockets of innovative thinking, there is a need for a more concerted effort in the profession to make a better contract product, and technology can facilitate this type of enterprise. Fortunately, the first step is already under way for us. Corporate clients are making their dissatisfaction with the design of contract documents louder and clearer. The next step is for the profession to think creatively about ways to address the unfilled contracting needs in the economy. Some of the disgruntlement, for example, focuses on the inefficiencies of contract enforcement, so that novel solutions may involve contractual redesign of the dispute resolution process and a more tailored relationship between that process and the substantive terms of contracts. Indeed, the profession and the legal academy could work together to explore these innovative opportunities, reflecting similar partnerships in engineering and other disciplines across the university. SL
This essay is based on a lecture titled “The Future of Transactional Legal Practice” that Triantis gave upon his appointment to the Eli Goldston Professorship at Harvard Law School in 2008 and on an article published this year, “Improving Contract Quality: Standardization, Technology, and Innovation in Con tract Design,” 18 Stanford Journal of Law, Business & Finance 177 (2013).
1Modularity in contracts means that one set of provisions can be altered or replaced without requiring significant adjustment to any other part of the contract.
2Early examples of contracts that come in legal, human-readable and machine-readable form are the various alternatives developed for Creative Commons Licenses: Three Layers of Licenses, http://creativecommons.org/ licenses/.
3Noam Scheiber, “The Last Days of Big Law: You can’t imagine the terror when the money dries up,” The New Republic, July 21, 2013.
4In a course Triantis teaches on contract design principles, the students are encouraged to think in these design terms and to think of markets for transactional products rather than individual clients.
5 The adversarial nature of legal representation in contract negotiation gives rise (unfortunately) to another source of value for the client, wherein the lawyer helps the client extract a larger share of the transactional surplus and protects against similar behavior by the other side. The value of an expert over an average representation in this regard is also complicated to assess.