Neuroeconomics and Innovation

I'm in LA for the next few days, at the Law, Economics and Neuroscience Conference: Implications for Innovation, sponsored by The Southern California Innovation Project, Theoretical Research in Neuroeconomic Decision-making (TREND) and The Center for Communication Law & Policy. As the press-release says, the idea is to bring together neuroscience researchers, economists, and ordinary law professors and see if the whole is greater than the sum of their parts.

[Gillian] Hadfield [who is organizing the conference on the law side] hopes the symposium will lead to more collaboration among scholars who may appear to have very different goals and backgrounds.

“You don’t usually find scientists, economists and lawyers talking together about the same topic,” Hadfield said. “I think people will find that we can enrich the research agenda of all these disciplines with this kind of cross pollination.”

I hope to blog the conference, or at least my parts in in, over the next few days. I'll be commenting on Mat McCubbins' co-authored paper, The Effect of Institutions on Behavior and Brain Activity: Insights from EEGs and Timed-Response Experiments. In the paper, on Boudreau, Coulson, and McCubbins found that identical cooperative behavior in a trust game seems to arise from distinct neurological mechanisms, depending on whether trust in others arose from incentives or penalties. After the session tomorrow I'll post some of my comments, which intend to connect this paper to the large law review literature on trust.

Posted by Dave Hoffman at 08:15 PM | Comments (0) | TrackBack

Can Dementia Diminish Consent?

Never at a loss for finding innovative ways to avoid liability, nursing homes are now pushing arbitration clauses onto residents. The trend raises some interesting contract law issues. For example,

[One family] hadn't realized they had signed an arbitration agreement at all . . . . But their six-page admissions contract with the Attala County Nursing Center included a paragraph requiring arbitration. It also said that if the family challenged the agreement in court they would have to pay the home's legal fees. That type of provision was declared "one-sided" and "oppressive" by the Mississippi Supreme Court last year in a separate lawsuit. But it helped pressure [the] family to accept the arbitration . . . .

A sidebar claims to offer some strategies for dealing with arbitration clauses:

Lawyers say patients should question admissions personnel closely. If an arbitration agreement is mandatory, they say, patients should write on the contract that they're being given no choice. "Write on the page, 'I'm signing this, because I was told I have to' " for admission, says Cleveland plaintiffs lawyer Blake Dickson, to try to make it easier to challenge an agreement in court.

Even the staunchest advocates of arbitration find these agreements troubling; the "biggest arbitration provider, the American Arbitration Association, frowns on agreements requiring arbitration in disputes over nursing-home care and generally refuses such cases." What's particularly ironic here is that much of the same political coalition that moved heaven and earth to respond to the Schiavo situation is behind the limits on lawsuits (and regulatory cutbacks) that make increasing risks of neglect and dehydration of the elderly a far more attractive business strategy.

Posted by Frank Pasquale at 08:12 AM | Comments (0) | TrackBack

Buying Silence

Can a company sign an airtight "nondisparagement" agreement with a departing employee? That's one question raised by this fascinating post at Above the Law. It reprints an email by a departing associate who essentially accuses a firm of trying to hide the real reason for her being let go. At one point she states:

As for your request for a release, non-disclosure, and non-disparagement agreement in return for three months' pay, I reject it. Unlike you, I am not just a paid mouthpiece with no independent judgment. I will decide how and to whom to communicate how you have treated me. I find it ironic that you would try to buy the right not to be disparaged after behaving as you have. Your actions speak volumes, and you don't need much help from me in damaging your reputation.

This is not my area, but I find work in the general field of regulation of information flow fascinating. This news story by Adam Liptak suggests that while "settlements for silence" are generally enforceable, there are several reasons why a beneficiary of one may not seek to enforce it. Richard Epstein has argued for a "better coordination" of contract and free speech law here, and his proposal would largely eliminate public policy exceptions (and First Amendment defenses) to enforcement. Epstein argues that "where true information is obtained illegally-- whether by trespass, fraud, or breach of confidence or contract--the presumption should shift sharply in the other direction, so that both damages and injunctive relief are made available to the party with the right to keep that information confidential."

Posted by Frank Pasquale at 08:12 PM | Comments (3) | TrackBack

Two Cheers for Indentured Servitude!

Yesterday, Mike asked the following question about legal education and the profession:

As I read these, they take as premise the proposition not merely that law schools should change how they teach because practice-based teaching is more effective, but that law schools need to fill a training gap created by the growing unwillingness of many law firms to train new lawyers themselves.

Why should that latter proposition be the case? It is reasonable to argue that clients should not be forced to bear the cost of training new lawyers. But why should the profession not expect law firm partners to shoulder that cost ­ rather than passing some or all of it back to law schools?

I think that part of the answer lies in the nature of the employment contract. Pushing the cost of training back on law schools is slighlty misleading. We are really talking about pushing the costs back onto students. One reason that law firms may be reticent about lavishing resources on the training of young lawyers is that they have few guarantees that they can recapture the upside of the training that they lavish. There are few ways of stopping young lawyers from taking the training and leaving for greener pastures, giving firms (and associates) an incentive to free-ride on the training provided.

Here, I think that it is useful to contrast the legal profession to the armed forces. The military spends an enormous amount of money training its recruits. On the other hand, the Army has much stronger remedies against employees who try to walk out on their employment contracts. Go AWOL and the MPs can track you down and throw you in the stockade. On the other hand, the system produces some superb training. For example, my understanding is that the airline industry is largely dependent on former military pilots to fly its jets. The reason is that to achieve the levels of proficiency that the airlines (and the FAA) demand a pilot must have an enormous number of flying hours, and as a practical matter it is nearly impossible for a student pilot to bear these costs individually. In other words, it is the remedial structure of the military contract that provides the intensive on-the-job training necessary to produce superbly trained pilots.

Perhaps we need something similar for lawyers. Apprenticeship indentures anyone?

[crossposted at madisonian.net.]

Posted by Nate Oman at 09:33 AM | Comments (15) | TrackBack

Specific Performance and the Thirteenth Amendment

I've put my new article -- "Specific Performance and the Thirteenth Amendment" (forthcoming from Minnesota) -- up on SSRN for your enjoyment. It examines one of those common claims that flits around legal argument, which everyone refers to and no one actually sits down and evaluates, in this case the notion that ordering specific enforcement of a personal service contract would constitute involuntary sevitude under the thirteenth amendment. Not surprisingly, the funnest part of doing this article was the historical research. The language of the thirteenth amendment was lifted almost verbatim from the Northwest Ordinance of 1787, which was then incorporated into the constitutions of Ohio, Michigan, Indiana, and Illinois before the Civil War. It was fairly common for slave owners south of the Ohio to take their slaves across the river and then attempt to circumvent prohbitions on slavery by having the slaves enter into long term "contracts" of service. When abolitionist or anti-slavery lawyers sued on behalf of the slaves -- generally petitioning for a writ of habes corpus against the slave owner -- the courts of Ohio, Illinois, and Indiana found themselves struggling with the problem of how to distinguish an unobjectionable labor contract from "involuntary servitude." Contra other scholars who have looked at the issue, I think that these courts developed a fairly coherent four part analysis for identifying involuntary servitude, and I think that this original understanding can be followed through the ratifying and implimenting debates over the thirteenth amendment and reconciled with the Courts haphazard treatment of the amendment since. Finally, while I do think that the specific performance of some personal service contracts could violate the thirteenth amendment, in a huge class of cases there is no constitutional impediment to holding a party to his or her contract, and I think that there are practical, economic, and moral advantages to doing so.

Here is the abstract of the article:

Black-letter law declares that a contract to perform personal services cannot be specifically enforced. Many courts, scholars, and commentators have claimed that to do so would constitute "involuntary servitude" under the Thirteenth Amendment. This claim, however, has never been the subject of extensive scholarly analysis. This article fills that gap and rejects the conventional wisdom. Neither the original meaning of "involuntary servitude" nor its subsequent interpretation by the Supreme Court justifies a per se prohibition on specific performance of such contracts. The non-constitutional arguments supporting the rule are likewise weak, and substantial policy and moral arguments counsel in favor of specific performance of at least some personal service contracts. Accordingly, this article concludes that the per se rule should be abandoned and that specific performance should be available for the enforcement of personal service contracts on the same basis as other contracts.

Download it while its hot!

Posted by Nate Oman at 12:06 PM | Comments (2) | TrackBack

Law Talk: A Roundtable on Justice and Insturmentalism in Private Law

Over the weekend, the Association for the Study of Law, Culture, and the Humanities held their annual conference at Boalt Hall. This podcast episode is a recording of a roundtable discussion on justice and insturmentalism in private law, which was organized for the conference by Jeff Lipshaw. The participants include Pete Alces (William & Mary), Robin Kar (Loyola LA), Alan Calnan (Southwestern), and Nate Oman (that's me). The discussion focuses on the philosophy of tort law and contract law, with Pete sounding a skeptical note using evolutionary biology. Enjoy!

You can subscribe to "Law Talk" using iTunes or Feedburner. You can also visit the "Law Talk" page at the iTunes store. For previous episodes of Law Talk at Co-Op click here.

Posted by Nate Oman at 11:01 AM | Comments (0) | TrackBack

Lipson on The BS That Didn't Bark: Why Didn't (Doesn't) Bear Stearns Go Into Bankruptcy Part II

This post concludes my colleague Jonathan Lipson's set of observations about Bear's bailout. You can find part I, in which Lipson demonstrates some of the advantages of a bankruptcy for Bear, here. Check out also Ribstein's response, here.

Why Didn't Bear Bark?

So, if the standard arguments against a BS bankruptcy don’t stack up, and in fact it might produce a better result than the hastily structured, poorly-executed deal on the table, why no bankruptcy?

The answer may be that while bankruptcy might benefit shareholders, JPM and other stakeholders, it would not benefit the folks who are in fact most likely responsible for the current state of affairs—BS’ officers and directors, and the managers of the hedge funds with whom they were intimately involved.

In any BS bankruptcy, insider transactions with the company of at least the last year—and probably quite a bit longer—would almost certainly be subjected to a searching inquiry. Most likely, a chapter 11 examiner would be appointed to determine what happened at BS, just as Neal Batson did at Enron.

Batson produced a huge report in Enron. Some would say it was not worth the price—allegedly about $100 million. But others would respond that Batson’s investigation did two very important things that created far greater value. First, his report was used in countless litigations that are said to have brought many times that amount back into the bankruptcy estate.

Second, his report revealed at least some of what really happened at Enron. My research on the use of examiners in chapter 11 cases suggests that this “public” value was, at least in the case of Enron, important because it gave lawyers and other professionals guidance on acceptable conduct well beyond that case.

In BS, scrutiny is likely the last thing that senior managers want. The media assumes that management is suffering along with everyone else because people like CEO Cayne had large share holdings, the value of which has been slashed. But this glosses over two important questions.

First, what did BS senior managers—and the management of the hedge funds they supported—get from BS over the last couple of years, whether in stock they sold for far more than $2 (or $10) per share, or cash bonuses, or compensation of some sort from hedge funds within or proximate to BS? These questions become relevant in bankruptcy because these transactions would certainly be scrutinized, and some may be avoided for the benefit of the bankruptcy estate.

BS’s senior managers doubtless understand this. It may be that for them, keeping last year’s goodie basket is worth far more than what they lose in the JPM deal. In a JPM deal—no matter how bad it gets for today’s shareholders—last years’ executive compensation is safe. Bankruptcy may put some or all of that at risk.

Second, and ultimately more important, there is the simple, cleansing effect of public scrutiny. Today, the question that no one asks—the elephant in the room—is where, exactly, all the money went? Of course, not all of it was real money. There was a lot of marking-to-model, which means that some valuations never really involved cash.

But lots of investors bought toxic securities from or through BS or affiliated hedge funds. And they paid cash. So, where did all that money go? Answering that question could go a long way toward understanding what went wrong in the mortgage crisis generally, and perhaps understanding how to prevent similar problems in the future. Today, thanks to JPM and the Federal Reserve, we won’t know.

In some ways, this is really about Sherlock Holmes famous dog that did not bark. There, after all other explanations were eliminated, only one—silence—made sense. Here, it may be that there are plenty of sound reasons to keep BS out of bankruptcy. But so far, it just looks like only one: the insiders want to keep the muzzle on.

Posted by Dave Hoffman at 10:56 AM | Comments (0) | TrackBack

Lipson on The BS That Didn't Bark: Why Didn't (Doesn't) Bear Stearns Go Into Bankruptcy

My colleague, Jonathan Lipson, is an incredibly astute observer of bankruptcy law and practice. I was talking with him the other day about Bear's bailout, and he offered some characteristically interesting thoughts. I invited him to share them in written form with our audience, and will be posting his comments in two parts today and tomorrow.

What’s so bad about bankruptcy?

Today’s New York Times reports that both shareholders and lock-up acquiror JP Morgan-Chase have threatened to put the financial firm into bankruptcy if the other doesn’t blink.

But, if bankruptcy is the only thing both sides agree on, why doesn’t the board authorize a chapter 11 filing?

Two classes of arguments have been made against a BS bankruptcy, one about market disruption, the other about value maximization. The cost, delay and uncertainty of bankruptcy could bring the whole system down, the theory goes. In any case, it would wipe out shareholders’ entire interest.

These are, of course, possible outcomes. But they’re not as likely as people think. In any case, the important question is not whether bankruptcy would do this, but whether ex ante we think bankruptcy would be worse than the current deal.

There is some reason to think bankruptcy might actually be better. If so, then something else may explain why BS, JPM and the Fed would rather spend the next couple of years in Delaware Chancery Court than the U.S. Bankruptcy Court for the Southern District of New York.

Market Disruption

Consider first the claim that a BS bankruptcy would irreparably disrupt fragile capital markets. A domino effect is possible, of course: First BS, then Lehman, then JPM, then Citigroup, until only Goldman remains to drool over the carcasses. Bear Stearns is, the thinking goes, simply “too big to fail.”

But this position loses force if we actually think about a how bankruptcy would likely play out.

First, bankruptcy would simply not touch at least some BS entities and many of their larger, system-sustaining transactions. Entities that are banks or insurance companies generally cannot be debtors under the Bankruptcy Code. While this would not keep the public parent company out of the tank, it would appear that at least some subsidiaries would be outside the reach of bankruptcy.

So, too for the major swap, derivative or repo transactions to which the company was party if it went into bankruptcy. These were the sorts of deals that were thought “too big to fail.” A BS bankruptcy would surely disrupt these trillion-dollar deals, the claim goes, thereby annihilating the economy and all of civilization.

But the reality is that’s not how it would work. In 2005, large financial institutions succeeded in having complex “netting” provisions added to the Bankruptcy Code (or expanding ones that already existed) precisely so that the bankruptcy of a major financial institution—e.g., Bear Stearns—would not otherwise disrupt the larger capital markets. These provisions do this by permitting non-debtor parties to close (“net”) out their positions without risk of the cost or delay of a bankruptcy. It would be as though bankruptcy never happened so far as those deals, and those counterparties, were concerned.

In any case, while the too-big-to-fail mantra may have resonance when applied to major commercial banks, it didn’t (at least in the past) send the Fed to rescue non-bank financial firms. Drexel Burnham was too big to fail, too, remember? But we seem to have gotten through their bankruptcy.

Second, to the extent that BS subsidiaries were statutory broker-dealers, bankruptcy would have to be a comparatively quick liquidation under special provisions of chapter 7, not the longer, more drawn out “reorganizations” we typically think of when we think of business bankruptcy.

True, a BS bankruptcy would probably halt future deal flow. But didn’t events leading up to (and including) the announcement of the JPM deal kill that activity? Bankruptcy can’t kill a dead dog twice.

Value Maximization
If bankruptcy law exempts truly system-critical transactions, and those were much of what BS did, what would a BS bankruptcy add? The answer is value maximization—or at least competitive valuation of some sort for those portions of the business that would go through bankruptcy, including the parent company.

This goes to the second argument usually advanced against a BS bankruptcy--it would kill shareholder value. Often, that’s true. But given the appallingly low price offered—even $10/share is a small fraction of its recent close—it is not surprising that many shareholders would prefer a gamble in bankruptcy.

Why? Because in bankruptcy, any major deal to sell or reorganize the company would likely result in some sort of competitive process that would drive the price closer to market. Committees of creditors (and probably) equity holders would vet any deal and object to a process that seemed to dampen value. For example, they might challenge the so-called “Bear Put”, which appears to permit JPM to keep the deal in play until shareholders finally give up. It might also put BS’s valuable real estate on the auction block, rather than give it to JPM no matter what, even as a breakup fee.

Because bankruptcy is increasingly a venue for the sale of assets—rather than traditional reorganizations—a court may well approve a controlled liquidation of the company. But it would almost certainly require a meaningful market test, to assure that the assets received the highest and best price. Today, even with JPM sweetening its offer, we have no idea what the real market value of the company is. The JPM process appears designed to make sure we never find out.

A related argument is that bankruptcy is a costly and time-consuming process. But here, too, there is less than meets the eye.

Those who would make this claim cite Enron, which took several years and hundreds of millions of dollars in professional fees. But the important question is not whether bankruptcy is costly—it is. Rather, the important question is whether, ex ante, it appears to cost more than the current deal.

Given the litigation that the JPM deal is likely to spawn, it is not clear why a well-managed (a big caveat, that) bankruptcy would be any worse. Is one or more roundtrips through Delaware Supreme Court likely to be quicker and cheaper than time on Bowling Green? Perhaps. But more than a half-dozen years of Disney litigation does not bode well.

A final (somewhat incongruous) argument is that bankruptcy would scare off JPM and/or the Fed, who have thrown a lifeline to BS. That may be, but given the deal's reception, it looks more like an anchor than a float was at the receiving end of the line.

More important, there is simply no reason JPM and the Fed could not have walked into bankruptcy court, arm in arm with BS, proposing the exact same deal that was inked March 16. The only difference would be that it would be subject to court approval. The fact that JPM head Dimon now “threatens” bankruptcy suggests he may understand this.

Indeed, the fact that this didn’t happen is especially baffling when you think about how much bankruptcy might actually benefit JPM. If they really were offering the best deal around—one that a competitive auction in bankruptcy would confirm—then they would also get the benefit of a discharge of most pre-bankruptcy BS liabilities. This means they would not have to worry about unanticipated liabilities—like lawsuits--haunting them after the fact. True, JPM agreed to guarantee a variety of BS obligations in connection with the acquisition. But that could all have been part of the deal run through—and approved by—the bankruptcy court. If it was the best deal going.

Posted by Dave Hoffman at 05:17 PM | Comments (5) | TrackBack

A Market in Rankings?

Complaining about law school rankings is a cottage industry in the legal academy. (Or rather more than a cottage industry, I suppose.) Everyone -- or nearly everyone -- dislikes the current system, and while I am less skeptical than most -- it doesn't seem unreasonable to me that students planning on shelling out $70,000+ in tuition might want some comparative measure of quality -- I agree that the current system leaves something to be desired. It seems to me that we could set up a market based solution.

A student recently suggested to me that inTrade ought to set up a prediction market in U.S. News Rankings. That way students could hedge against the risk that the value of their degree may drop if their school shifts in the rankings. It is not a bad idea, but the problem is that such a market -- while allowing a bit of U.S. News risk arbitrage and hedging -- would ultimately be about simply predicting the mysteries of the U.S. News system. Suppose, however, that we set up contracts for something other than U.S. News status. For example, one might purchase a contract predicting that West Dakota Law School's graduates would have an average starting salary of $100,000 or more. This would provide information of the kind that most students care about. Alternatively, one might create a contract that pays out if East Carolina Law School's faculty places 10 articles in top-ten law reviews this year or some other measure of scholarly accomplishment. Then we could compare the share prices for Harvard and Yale. Of course, we would still just be getting a market in prediction of a particular outcome, rather than actual quality, but it might not be a bad proxy and it might capture more of the dispersed knowledge about law school quality. Of course, in order for the system to work you would need a relatively thick market in the contracts offered and even if there were only three or four contracts per law school, the number of contracts available in the market would be huge. On the other hand, law profs and law students are nothing if not obsessed with status, and I suspect that there would be a sizable contingent eager to cash in on their obsession.

What do you say? What contracts do you think inTrade should offer?

Posted by Nate Oman at 12:59 AM | Comments (3) | TrackBack

Random thoughts on the doctrine of consideration from my drive to work

Theorists of contract law have generally assumed that one of the more important questions that they ought to answer is "What promises should the law enforce?" After all, no society makes all promises legally enforceable. We wouldn't want people to be able to sue over a broken promise to do lunch would we? The result is the doctrine of consideration, a conceptual muddle that delights law professors, confuses first year law students, and -- as near as I can tell -- makes little or no difference in actual practice. I wonder, however, if the whole thing isn't a solution to a pseudo-problem.

Take the promise to do lunch. We wouldn't want people to sue over such a trivial thing, so we need some doctrine by which the lunch promise isn't legally enforceable. But why, I ask. As it happens, a sufficiently imaginative lawyer and a Cardozo-esque judge could probably find consideration on the promise to do lunch. And yet there is very little litigation on the subject. Why? The answer is pretty obvious: lawsuits are expensive and the damage suffered by the disappointed promisee in this hypo is trivial. It doesn't pay to sue. The obvious answer, however, has a potentially important implication for contracts, namely that the cost of litigation rather than the doctrine of consideration is the real keeper of the gate between "legal" promises and trivial promises with which the law is unconcerned. If that is the case, however, then perhaps we needn't ask the question "What promises should the law enforce?" at all. Just say that any promise that is sufficiently definite may be sued upon. The result will not be a flood of litigation. To see why, consider the tort of battery. I am constantly subjected to un-consented-to touching when I jostle folks on the side walk. (Or at least I was before I moved to a town with more geese than people.) Yet the court system is not awash in battery cases. And so, it seems to me, it could be for promises.

Posted by Nate Oman at 10:22 AM | Comments (11) | TrackBack

A New Blog

Welcome to the blogosphere Commercial Law Blog! The opening posts include the history of commercial law, Starbucks, and the morality of trade. Good stuff.

Posted by Nate Oman at 10:05 AM | Comments (0) | TrackBack

Battlestar Galactica Interview Part II

Dave Hoffman, Deven Desai, and I are pleased to present Part II of our interview with Ron Moore and David Eick, the creators, producers, and writers of the hit television show, Battlestar Galactica.

Part I of our interview explored the role of law in the show, exploring topics such as the legal system, lawyers, trials and tribunals, torture, necessity vs. moral principles, and deference to the military.

In Part II of our interview, Dave Hoffman interviews Ron and David about politics and the economy. How did the political system of the Twelve Colonies work prior to the cylon attack? After the destruction of the colonies, how does the economy work aboard the fleet? Why do people still continue to do their jobs without compensation? How does commerce work? Why do people still use money? Dave examines these fascinating questions and more.

Part II of the interview is 13 minutes, 57 seconds long. You can also access it, along with Part I, here.

Check back Tuesday morning, when we plan to post Part III of our interview -- the final part -- which addresses issues involving the cylons.

UPDATE: The interview has now been transcribed. You can read Part I here, and Parts II and III here.

Posted by Daniel J. Solove at 12:03 AM | Comments (0) | TrackBack

Preaching to the Court House and Judging in the Temple

I have put up a couple of posts here on my on-going research on the resolution of civil disputes in ecclesiastical courts.The full version of my research is now up on SSRN for those interested. Here is the abstract:

A number of American religious denominations - Quakers, Baptists, Mormons, and others - have tried with varying degrees of success to opt out of the secular legal system, resolving civil litigation between church members in church courts. Using the story of the rise and fall of the jurisdiction of Mormon courts over ordinary civil disputes, this article provides three key insights into the interaction between law and religion in nineteenth-century America. First, it dramatically illustrates the fluidity of the boundaries between law and religion early in the century and the hardening of those boundaries by its end. The Mormon courts initially arose in a context in which the professional bar had yet to establish a monopoly over adjudication. By century's end, however, the increasing complexity of the legal environment hardened the boundaries around the legal profession's claimed monopoly over adjudication. Second, the decline of the Mormon courts shows how allegiance to the common-law courts became a prerequisite of assimilation into the American mainstream. While hostility to the secular courts had been a hallmark of a major stream of American Protestantism during the colonial period and the first decades of the Republic, by the end of the nineteenth century, Mormons' rejection of those courts marked them off as dangerous outsiders. Part of the price of their acceptance into the national mainstream was the abandonment of legal distinctiveness. Finally, the story of the Mormon courts also illustrates the importance of law for the development of religious beliefs and practices. Other scholars have documented the "public law" side of this story, showing how the federal government's effort to eradicate Mormon polygamy was central to Mormon experience in the last half of the nineteenth century and ultimately forced a revolution in Mormon beliefs and practices. The rise and fall of the Mormon court system, however, shows that private law could exercise no less of a power over the religious imagination.

Dowload it while its hot!

Posted by Nate Oman at 12:41 PM | Comments (0) | TrackBack

Offer, Invitation, or Joke?

In honor of Leonard v. Pepsico, 88 F.Supp.2d 116 (1999), which I am teaching today in my contracts class.

Posted by Nate Oman at 11:27 AM | Comments (2) | TrackBack

Tipping Points and Viral Law

Which channels for legal authority are most efficient? This enforcement-efficacy question is a tough one, understudied by traditional L&E and even BL&E. Most instrumentalist theories of law spend relatively little time thinking about the costs of distributing legal rules, and the likelihood that their recipients (citizens) will internalize them. Indeed, the basic L&E approach to criminal law (Becker's) is frankly dismissive of law's signaling function, and equates criminal and civil wrongs as taxable infractions.

The problem is not confined to criminal law, of course. Imagine that we want to promote good behavior by a corporate officer. Traditional corporate law doctrine says that we should do so by tinkering with legal rules ("the duty to auction should attach at a Revlon moment"; "Revlon doesn't happen unless control transfers apart from a distributed market transaction"; "officers must seek Board approval for corporate opportunity taking"; etc.) These doctrinal choices are framed against an incentive problem (principal agent). Richer motivational accounts complicate the story: maybe officers won't be incented to avoid negligence by imposing a care rule; maybe monitoring rules will increase distrust). But even behavioral law and economics assumes that the way that law is pushed out to its targets is basically immaterial to whether it is effective.

This is the standard, hierarchical, model of distributing law. Different approaches, born out of network theory, are of course possible. Malcolm Gladwell's The Tipping Point illustrates the point. Gladwell popularized the idea of the "law of the few": "The success of any kind of social epidemic is heavily dependent on the involvement of people with a particular and rare set of social skills." He further identified connectors (people who "link us up with the world ... people with a special gift for bringing the world together"; mavens ("people we rely upon to connect us with new information."); and salesmen ("persuaders"). Finally, he suggested that some messages are more sticky than others. (Source for the quotes: Wikipedia) .

How would these insights apply to law? Well, obviously, we might imagine Judge Hercules thinking about a change in the law. She has some criterion to evaluate the goodness of that change. [Be it Kaldor-Hicks efficiency, or something as subtle as de-biasing a pernicious cognitive error, or maybe a fMRI readout of a few brain scans, or maybe she just flipped a coin. Don't be distracted by the mechanism, stick with the story!] Once she's made the decision, however, she wants the greatest number of people in society to follow her new rule, so as to maximize the benefits she thinks flows from the change. L&E and BL&E have, to date, said almost nothing about this distribution and enforcement problem. (Indeed, as I learned from Alex Rasholnikov's workshop at Temple this week, tax folks haven't done much on enforcement either.) So, she follows the conventional wisdom, issuing her decision in an opinion, or an order if she thinks it likely to be unappealled, and assumes that individuals will learn about the new legal rule in the traditional ways - the media, by word-of-mouth, and by personal experience with the policeman's stick.

Gladwellians, however, might imagine the legal change as a proposed social epidemic, and the judge's goal to make that epidemic travel as fast, and as widely, as possible. She also wants the epidemic to stick - to embed itself in individuals' daily behavior, so that post-hoc enforcement costs are low. Thus, she might want to find connectors to send her decision to (bloggers!); talk with mavens about the rules so they can explain them to others (law professors!); and then somehow enlist salesmen to her cause (friendly litigants). To make the message as sticky as possible, she might want to dress it up with provocative rhetoric, or maybe even embed some multimedia in the opinion itself. In short, Gladwell can explain many of the features of the way that the common law today is distributed, and makes sense of, say, the Delaware Supreme Court's tremendous success at increasing their market share: the justices of Delaware understand the law of the few!

There's just one problem with this story: it may not be right. Duncan Watts performed a large-scale experiment to test whether nodes improved virus transmission:

In 2001, Watts used a Web site to recruit about 61,000 people, then asked them to ferry messages to 18 targets worldwide. Sure enough, he found that Milgram was right: The average length of the chain was roughly six links. But when he examined these pathways, he found that "hubs"--highly connected people--weren't crucial. Sure, they existed. But only 5% of the email messages passed through one of these superconnectors. The rest of the messages moved through society in much more democratic paths, zipping from one weakly connected individual to another, until they arrived at the target.

If Watts is more right than Gladwell, it poses a challenge for jurists: what is the most efficient way to distribute legal rules, where you can't rely simply on nodal governance. Because this blog post is already too long, I think I'll leave the question open to solicit your thoughts.

(Image Source: The Sick Doctor, Jehan Georges Vibert)

Posted by Dave Hoffman at 04:57 PM | Comments (3) | TrackBack

Borat Gets His Forum

It's been widely reported that Sacha Baron Cohen and his production company won a forum selection clause motion in Alabama yesterday. As a result, etiquette teacher Kathie Martin, who was embarrassed in Borat, will have to sue in New York. I'd imagine that the case suddenly has significantly less settlement value, even assuming that she pursues it up North.

I wish I could tell you more about the lawsuit, but I can't find the opinion online. The Alabama Supreme Court website charges a ridiculous, Bar-protecting, $200 a year for access to its opinions. But for first-year contracts students who are now taking civil procedure, the case is a good example of why the former class is much, much more important than the latter.

Posted by Dave Hoffman at 02:13 PM | Comments (5) | TrackBack

The New Hall Monitors

The front page of today's Washington Post reports on a recent explosion in the number of corporate "monitorships," noting a sevenfold increase since 2001. In these cases, the article reports, federal prosecutors direct contracts to private parties, who are given responsibility to oversee sometimes radical reconstructions of companies charged with fraud or other wrongdoing. The often hefty bill, of course, goes to the relevant company.

Much of the analysis in the article speaks to potential corruption/favoritism in the appointment of individuals to fill these lucrative positions. The article notes the appointment of "various former prosecutors and SEC officials with ties to President Bush, his father and other Republican luminaries," before focusing on a particular case out of New Jersey. (Which choice I saw, as a perhaps overly defensive temporary resident, to play on pernicious stereotypes of this fair state...)

I was more interested, however, to think about the nature of the institution of "monitors" more generally. What, I wondered, were potential analogies in our schemes of law and governance? Court-appointed special masters immediately came to mind. Naturally, there's some whiff of our sorely missed independent counsels. Perhaps given my international interests, I somehow thought of the U.N. trusteeship system as well, which in turn brought to mind the various uses of private trustees in the U.S. bankruptcy system.

Wtih full appreciation of the significant variation captured by this litany, what might we say generally about the use of monitorships and similar institutions as mechanisms of regulation? All, of course, involve a certain delegation of monitoring, counseling, and even disciplining functions. But what motivates that delegation? What institutional gains do we understand to follow from such delegation? I assume it's not simply a matter of cost-savings or some general notion of relatively greater efficiency of the private sector. The latter isn't out of the question, of course: Taking the case of monitors by way of example, it's clear, at a minimum, that corporate payments for the privilege of being monitored are more easily made to private monitors than they would be to a public servant or even the agency for whom she acts. And perhaps private monitors are somewhat more likely to be fastidious in their monitoring, given their profit motive (though it's not entirely clear how that motive would play itself out in the particular institutional context of corporate monitorships).

But I wonder whether the operative notions of regulatory "efficacy" behind the use of monitors (and analogous institutions) don't also involve some substantive evaluation of the comparative advantages of public versus private institutions, in varied regulatory settings. The Post thus cites "a shift from lodging criminal indictments against businesses for fear they will collapse and cost employees their jobs. Instead, the government has taken a different path: forcing companies to submit to outside oversight at their own expense as a condition of settling fraud and corruption cases."

Perhaps, this might be understood to suggest, there's some notion of comparative institutional efficacy at work. While public regulators may be quite effective at penalizing behavior, perhaps they are less effective at changing it? To similar effect, perhaps public institutions are good at defining relevant boundaries, but less effective at more nuanced, day-to-day classifications of relevant behavior? Assuming public institutions enjoy a comparative advantage at least at some things, though, greater attention to questions of relative regulatory efficacy would seem to be in order.

Beyond the fascinating question of what institutions such as monitors imply for our understandings of regulatory design, a distinct (and no less fascinating) issue concerns the contracts by which the relevant relationships are established. Assuming a single contract, who are the parties in privity and who is the third-party beneficiary of the contract? At what level of detail are the contracts drafted? And what, perhaps more oddly, what might be the remedies for breach?

Posted by Robert Ahdieh at 10:58 AM | Comments (0) | TrackBack

The Singing Contracts Prof

Things that I as of yet lack the confidence to do in my classroom. (And as a bonus, there is a longer version.)

Needless to say, however, I think that NPR has demonstrated its utter lack of insight by suggesting that contracts is tedious.

Posted by Nate Oman at 03:50 PM | Comments (2) | TrackBack

What's Wrong With A Company Paying for a CEO's Family to Fly?

Michelle Leder, of Footnoted, was on NPR's Marketplace yesterday. The story: the worst examples of agency-costs in footnotes in SEC filings in 2007. (She doesn't sell it that way, but that's what it is.)

Bloggers have highlighted a few of Michelle's "best" finds, including Edward Mueller's agreement, as CEO of Quest, to permit his family members to use the company plane to travel back and forth to California (where his family was based) to Denver (where Qwest is headquartered.) Although the story was hyped as permitting Mueller's daughter to commute daily to school -- something of a modern-day Leonard v. Pepsico, there is no evidence that the family plans to fly back and forth in this way.

But who cares anyway? Increasing numbers of high-level executives work far away from home, commuting to headquarters for parts of the week. (The consultants' four day week, but permanently.) Encouraging them to do so maximizes shareholder wealth because it (presumably) allows recruitment of talent that wants to live elsewhere. Now the problem with these schemes is that it is taxing for the executive and her/his home life to be separated from the family. As Professor Joan Heminway explains here, personal turmoil in a CEO's life can have materially adverse consequences for shareholder value, and well-run companies probably ought to do everything they can to make executives personally happy.

So why not pay for a family to commute back to California, to enable a family member to finish her last year of high school surrounded by friends, while coming "home" to Denver when possible? If that makes Mueller happy, and reduces the chance that he would live in California and commute to Denver, Qwest's shareholders win. If the argument is simply that the CEO should pay for this travel out of his own pocket, the flight costs will be imputed as income to him under the agreement, so the economics are basically the same. Given disclosure, these kinds of perks should be seen simply as salary-substitutes, at worst, and as ways to reduce the chance of disruption by increasing the CEO's chance of having a normal family life.

Dailykos (which originally brought the story to my attention) had this to say:

And as this president likes to remind us, this is the ownership society, so don't be surprised to learn that some of your retirement funds are going to fuel up that jet so an execu-kid can zip off to the prom.

But this is plainly silly. Would we prefer that Qwest simply paid Mueller more money? Or not disclosed the behavior?

Posted by Dave Hoffman at 06:56 PM | Comments (3) | TrackBack

More Davidoff-Ribstein-Lipshaw on the Cerberus-URI Case

Steve Davidoff over at M&A Law Profs Blog has more on this opinion, about which I posted several days ago, and with Larry Ribstein's first and second posts, we may have now beaten the three-headed dog of hell to death. But not quite.

I want to address Larry's suggestion that Chancellor Chandler has issued a warning to lawyers using "notwithstanding" and "subject to" clauses in complex agreements not to do so because they create ambiguities that effectively require the court to go beyond the document to things like the "forthright negotiator" doctrine. That argument depends on the following thought process actually occurring in the mind of a lawyer about to propose a change to an agreement: "Chancellor Chandler in Delaware has suggested that it is inartful drafting to have a syntactical and grammatical correct overriding of a provision where the content of the two provisions is contradictory. Rather than handle the deal-making problem in this way, which is NOT ambiguous, but merely Rube Goldberg-esque (linguistically speaking), I should confront the other side head-on with the issue, recognizing that we may have a purer document. In doing so, I have decided that the risk of this issue being screwed up by a court in the event of litigation weighs more than the risk of doing something to cause the deal not to close (e.g., triggering further discussion of the provision, losing a face-saving way of resolving a disagreement, causing another round of revisions in a time-sensitive environment, etc.)"

It's an interesting situation where theory, I think, has to give way to practice. My casual empiricism says lawyers make that calculation doing deals all the time, in one form or another, but that the conclusion is almost always to let either difficult construction or even ambiguity stand for fear of wrecking the deal. (That's the gist of John Coates' expert report.) If I were to resort to behavioral psychology and economics, I'd suggest that risk aversion accounts for the ex ante choice - between taking the present deal and the risk of either losing the deal or having an adverse outcome in litigation, we select the certainty of doing the deal - and hindsight bias accounts for the ex post analysis.

In my day, I negotiated some of the most arcane and difficult risk splitting provisions possibly in the history of contract drafting - for example, multiple overlapping indemnification buckets for different kinds of risks like environment, patent, product liability, and so on - all on the thesis that getting cash for the business now outweighed the risk that we somehow had either royally screwed up the contract, or that some unknown liability would come crashing down on us in the future. Most deal lawyers never want to look at an agreement once the deal is closed, because as I've said, you pays your money and you takes your chances, and just hope to hell that it all works out.

Or as one of the finest deal lawyers I ever knew, my former boss and later colleague at AlliedSignal, Martin Cohen, used to say, when you are selling a business, the best insurance against lawsuits is that the buyer succeeds wildly with it.

Posted by Jeff Lipshaw at 09:42 AM | Comments (1) | TrackBack

The Cerberus Case and Lessons in Law, Society, and Language

Over in the M&A world (that's mergers and acquisitions for all you non-corporate types), there's a recent decision from the Delaware Chancery Court, written by Chancellor William Chandler, that is getting a fair bit of play in the blogosphere, including from my friends Larry Ribstein and Steve Davidoff.

One of the reasons I love complex acquisition agreements as the subject of contract theory is that, like life, they are incredibly complex. No mere agreement to buy 100 bushels of wheat in thirty days at X dollars per bushel here! No, the agreements attempt to map a highly contingent future, one in which the environment or the businesses can change, financing may not be available, bet the company lawsuits can be filed, shareholder actions begun, and so on. I've argued before that language is often a blunt instrument used to capture the fine lines of an understanding.

I've not fully studied the opinion, but it is a fine piece of analysis, even where in very subtle ways I disagree with it. And with all due respect to Larry Ribstein and Steve Davidoff, I think Chancellor Chandler has a better feel for the limitations of law and language. Yes, this could be "sloppy drafting," but as I alluded in an earlier post, lawyers, for all their pretensions of being at the center of a deal are often flies swarming around the galloping steed that is the deal itself, and the focus on the contract as the source of the problem is merely a fly's-eye view.

In simple terms, what is the issue? Section 9.10 of the agreement says that the merger target (i.e. the company whose shareholders are going to walk away with cash - let's call it the seller for ease of reference) has the right to enforce the agreement by injunctive relief for specific performance for a whole bunch of things, including forcing the deal to close. But Section 9.10 says it is "subject to" Section 8.2, which says "notwithstanding" any other provsion in the agreement, the seller's sole remedy if the buyer walks away is a $100 million termination fee. The buyer walks away, and the issue is simply whether it must close under 9.10 or can walk away for a price of $100 million under 8.2. Got it?

Chancellor Chandler's opinion says (i) the language is ambiguous on the walk-away right, but (ii) the circumstances of the negotiation make it clear that the seller understood its rights were limited to the $100 million walk-away fee. The crux of the ambiguity (and the source of the "sloppy drafting" criticism) is the fact that one provision (the "left hand") appears to be taking away what another provision (the "right hand") is giving. Why would that happen? And, indeed, there was testimony to the effect that it would have been clearer if one of the provisions had been deleted rather than having this "subject to/notwithstanding" trumpery.

I have read the two provisions, and I don't think they are ambiguous. From the standpoint of the logical construction, the contract is doubly clear that the walk-away right dominates over the injunctive right. This, it seems to me, is as close as we come in the law to a semantical paradox, like the Liar's Paradox ("this sentence is false"). The problem is that the grammar and syntax are absolute clear, but we rebel against the contradictory content. In short, why is it there? Try this: "Underlying the semantical paradoxes is our naive intuition that 'paradoxical sentences because they are not ungrammatical, vague, or sortally suspect and encompass no false presuppositions, must yield statements when used.'" (Oren Perez, "Law in the Air: A Prologue to the World of Legal Paradoxes," in Perez & Teubner, Paradoxes and Inconsistencies in the Law, quoting L. Goldstein, "A Unified Solution to Some Paradoxes," in Proceedings of the Aristotelian Society.)

Perhaps it is because I have actually been in the shoes of an M&A lawyer trying to craft a linguistic solution, or have been the client of M&A lawyers trying to craft linguistic solutions for me, that I chuckle at the charges of "sloppy drafting" as though lawyers have the absolute power (a reductive, rational, scientific, but unrealistic assumption) to control all outcomes through language. One of my rules of thumb in negotiating language was to change as little as possible to achieve the desired outcome. That's an art not a science, and Cerberus' lawyer's judgment ultimately bore out in this case. Who knows what would have happened if he tried to make the change by deleting rather than trumping?

Moreover, we don't know what the lawyers were saying to their clients. We do know from the testimony that the seller's lawyers understood that the walk-away right essentially created a $100 million option. How do we know that the following conversation did not occur in the seller's executive suite or boardroom - "look, we aren't going to do much better than this - we will be able to make an argument there's an ambiguity on the walk-away right, but Cerberus is probably going to win it in the end. On the other hand, the worst thing that happens if we lose is that we get $100 million, and that should be a sufficient litigation war chest if we want to pursue an injunction."

My point is that the contract, as important as it is, is only a piece of the entire social system that is a complex business acquisition. There can be sloppy drafting, but that's an easy default.

For those interested, I've addressed this previously in two respects: (a) the illusion that there was an original mutual intention of the parties when a contract is later capable of colorable conflicting interpretations (The Bewitchment of Intelligence: Language and Ex Post Illusions of Intention, 78 Temple L. Rev. 99 (2005), and (b) the lawyers' illusion that a contract is the deal (i.e. the game), when in fact it is just a model of the deal.

UPDATE: Larry Ribstein has an insightful follow-up to my comment here, and Steve Davidoff offers a detailed analysis here.

Posted by Jeff Lipshaw at 09:57 AM | Comments (1) | TrackBack

ECCO Shoes, Transaction Costs, Reputational Norms, the Limits of the Legal System, and Internet Disintermediation

On October 15, 2007, at the recommendation of my wife, I bought a pair of ECCO shoes at what, for me, was an ungodly amount to pay for a pair of shoes. The reason for the investment is that we live in a city now, and I do a lot more walking. (For comparative purposes, I buy all of my shirts from Lands' End, and my pants are whatever Dockers - pants for the bigger butted man, as my daughter Arielle and Dave Barry say - are on the table at Costco. So buying shoes at a chi-chi store on Newbury Street was an unnatural act.)

About six weeks later, I happened to notice that the heel had worn through. I wear these shoes a fair amount, but it didn't seem to me that a pair of shoes at this ungodly price should wear through in six weeks. You can't just take shoes back to the ECCO store, however. You have to order a prepaid bag from customer service, and send the shoes away to an outsourced "warranty service," which makes a unilateral judgment whether ECCO will do something about the problem. I duly packed them up and send them away.

The warranty service received them yesterday, and the following is now posted online under my repair ticket: "WEAR IS NOT A DEFECT NORMAL WEAR NO DEFECT."

From time to time, I teach contracts! I think there's at least a fact issue whether a sole wearing through in six weeks of relatively normal wear on a pair of $190 shoes constitutes a breach of the implied warranty of merchantability under Section 2-314 of the U.C.C. I channeled Ronald Coase a few minutes ago, and he told me that in the absence of transaction costs, clear default rules, and freedom of contract, the initial allocation of legal rights as between ECCO and me would be irrelevant to an efficient outcome. And when I channeled Frank Easterbrook, he referred me to Hill v. Gateway 2000, and told me I was bound by a warranty disclaimer that was available on the ECCO website if I had read the sales slip and clicked my way through to find it before I wore the shoes.

I am not finding either of those results particularly satisfying at this minute. But wait! I also channeled Lisa Bernstein who has studied diamond brokers in New York City, and they don't rely on formal law. Do a deal, say "mazel v'broche" (luck and blessing), and reputational norms will do the rest. Hmm. I wonder what that means, if anything, in a world of internet information disintermediation. I'm kind of a "you pays your money and you takes your chances" on this kind of stuff anyway. Personally, that's the last pair of ECCO shoes for me. But you can make your own decision.

Posted by Jeff Lipshaw at 09:27 AM | Comments (5) | TrackBack

Law Talk: George R. R. Martin

In today's episode of Law Talk, we hear from George R. R. Martin, the prolific author of the "high fantasy" series The Song of Ice and Fire. George has also been a screenwriter and Hollywood producer, an editor, a chess tournament director, a union leader, and a volunteer media director for the Cook County Legal Assistance Foundation. As I've previously written, George is a leader in the movement to bring a degree of realism to fantasy, and he has been dubbed (by Time Magazine) "The American Tolkien."

George and I talked for almost an hour, on topics ranging from the role of law in fantasy books (starting 3.5 minutes in); the limits of magic as a plot device (20 minutes in); law professor Robert Cover (22 minutes in, brought up by me, to my shame); why most fantasy novels seem to be set in merry olde england (28 minutes in); fan fiction and copyright infringement (31minutes in); how writing sci-fi is like selling music, and whether he likes Radiohead's distribution model (35 minutes in); how to keep control over your work when it is transformed into another medium (39 minutes in); and inheritance law (toward the end).

George is a fantastically interesting, well-read, thoughtful guy, and I think you will enjoy this interview quite a bit. (If you aren't a fan of the books, ignore my constant, irritating, references to characters you have never heard of.) Finally, if you want to learn more about George, visit his blog (which he says isn't one) and join the hordes of folks waiting for the next installment of the series, A Dance With Dragons, to ship.

Missed the link? Here's the interview again. Warning: it's a big file!

You can subscribe to "Law Talk" using iTunes or Feedburner. You can also visit the "Law Talk" page at the iTunes store. For previous episodes of Law Talk at Co-Op click here.

For other posts in the "Law and Hard Fantasy" Interview Series, see:

• Fantasy’s Apocalyptic Turn
• The Law and Hard Fantasy Interview Series
• An Interview with Pat Rothfuss

Posted by Dave Hoffman at 12:26 PM | Comments (28) | TrackBack

Confronting Contractors

There's a nice review of Barry B. Lepatner's Broken Buildings, Busted Budgets in the WSJ today. Lepatner offers an interesting economic model of traditional business methods here:

Firms aren't really competing to deliver quality for the lowest possible price. Instead, according to Mr. LePatner, "they compete for the future right to increase the initial cost of their agreement.". . . "We end up with many firms," Mr. LePatner writes, "but little head-to-head competition on the big economic variables of time, quality and price."

Construction firms often make unrealistically low bids to get jobs, Mr. LePatner notes, but they can count on finding plenty of reasons later to jack the price up enough to allow for a profit. When the building is under way, it becomes prohibitively expensive to fire the contractor and start anew. The owner has become a hostage.

Yet another reason to suspect "lock-in" as a business model. On the bright side, LePatner suggests that cyberspace's enhancement of "reputation nation" should make experiences like our guest Jeff Lipshaw's less likely in the future:

[LePatner suggests] hiring experts who can monitor builders and who have financial incentives to prevent needless overruns. Tougher contracts should enforce fixed costs or, at least, severely limit the scope for escalation. And thorough background checks -- looking for lawsuits, public complaints and financial troubles -- may lower the chance of hiring dodgy engineers and construction teams.

Photo Credit: night86mare.

Posted by Frank Pasquale at 09:46 PM | Comments (0) | TrackBack

A Nod to Angie's List as an Alternative to Contract Law

As I've written in Models and Games, I th