Doing deals in school
A prof talks about teaching transactional law
By Jonathan C. Lipson
In theory, there is no difference between theory and practice. In
practice, there is. — Yogi Berra.
How, if Yogi Berra is correct, should law schools train business lawyers?
This question has been asked — if not answered — many times.
About a dozen years ago, Robert MacCrate suggested in his landmark ABA
report on legal education that transactional skills training should be a
basic part of law school. Before that, in 1975, Skadden Arps corporate
partner James Freund collected his professional insights into a
novel-length manifesto of practical advice about mergers and acquisitions
work, Anatomy of a Merger. Indeed, even one of the dominant legal
theories of the 20th century — legal realism — exhorted
professors to teach students law that "matters" — the law
lawyers use, and the ways that lawyers use that law.
Given the frequency of these calls for reform, you might think that
teaching transactional business law has been a failure. There has, however,
been quiet progress. In a recent article, "Teaching Transactional
Law," UCLA law professor Kenneth Klee observed that
"transactional courses have penetrated the legal curriculum to a
significant extent." Klee surveyed most U.S. law schools and learned
that, of the 40 that responded, at least 38 offered some kind of
transactional course, defined as one "focusing primarily on the
parties or their professionals in the formation, negotiation,
documentation, or consummation of a business deal." While it is
difficult to rely too heavily on Klee's results — he received data
from less than 20 percent of ABA-approved law schools — it appears
that law schools are starting to take transactional lawyering
seriously.
But Klee has an important caveat: His survey does not consider whether law
faculties actually teach transactional skills well. This is an
important qualification, because it is easy to imagine that teaching
business transactions law presents at least three challenges for law
schools:
First, the dominant classroom model — reading and analyzing
appellate decisions — applies only indirectly to the lawyering of
most business transactions. Second, if anecdote is accurate, legal academics themselves rarely
practiced transactional law. Third, and perhaps most important, comparatively little
"theory" has been brought to teaching transactional skills. That
is, even if we teach students "how" to do deals, we are just
beginning to connect these skills to the deeper questions: "Why are
deals done, and why do lawyers matter in them?"
This article describes my attempt to address these issues, through a course
I developed at the University of Baltimore (and now teach at Temple Law
School), the "Transactional Skills Workshop" (the workshop). The
workshop has two basic goals: to immerse students in the reality of
deal-work, and to show them how this work fits into the larger theoretical
framework taught in most U.S. law schools.
The workshop is a simulation involving the formation of a high-tech
business, and involves three core parties:
a pair of imaginary entrepreneurs named Karl Llewellyn and Soia
Mentschikoff (the founders), Aether Systems, a (real) wireless technology company, and the Founders'
soon-to-be-former employer (Aether), and James Brown, an angel investor (the investor).
Like most entrepreneurs, Karl and Soia have a good idea that they developed
at their day jobs at Aether (as a marketer and engineer, respectively). In
this case, Karl and Soia have an idea about how to use Aether's operating
system to develop a wireless payments technology.
Their boss at Aether, Grant Gilmore, likes the idea, but this is outside
the scope of Aether's business plan — not least because Aether is
about to sell its wireless technology assets to another company. (Although
everything else in the simulation is made up, this part is true —
Aether is a real company that did recently divest its wireless technology
business). Gilmore thinks, however, that he can assure Karl and Soia of a
license of Aether's operating system, at least to develop their own product
— if they give Aether (or its successor) stock in their new company.
Meanwhile, James Brown, the investor, has said that he would be willing to
invest from $5 million to $10 million in the startup company, which
(because I cannot resist a pun on Aether's name) will be called
"Either/Or."
This setup differs from many transactional courses in at least three basic
respects. First, the problem involves three core sets of parties (founders,
former employer and investor) — not two (such as buyer/seller), as
is often the case. This makes the simulation more realistic and interesting
— but also more difficult. In the negotiations that ensue, parties
will often gang up on one another, play one off against the other, and
otherwise engage in the strategic bargaining we often see in the real
world.
Second, the students play the parts of both the various parties and
their lawyers. This differs from most other simulations, which have the
teacher or outsiders playing the client roles. I don't do that, because I
think a good way to learn to be a lawyer is to be (or at least to view the
world as) a client.
Third, the class is limited to 18 students, and is then broken up into
three teams of six players (three core parties, each with a lawyer). Each
of the six players on each team gets an individual set of background facts
tailored to his or her role, explaining what that party/lawyer wants from
the deal, what they are willing to give up in negotiations, what they won't
give on, what they fear, etc.
So, for example, the student playing the founders (Karl/Soia) will get a
fairly detailed memo about how much money they want to raise, how much
stock they want in the company to be formed, the kinds of rights they want
their shares to have (regarding dilution, priority, further sales, etc),
and some important details about their relationship with Aether (such as
details about their employment agreements). Their lawyer, by contrast, will
get a much shorter memo, explaining how the lawyer got involved, what the
lawyer wants (getting paid, for example), and some concerns the lawyer
might have about the deal (what's in the founders' employment agreements
for example).
I provide similar memos with (what I hope are) interlocking facts for the
other parties (Aether and James Brown, the investor), and their respective
lawyers. The idea is that if all six memos were put together, the students
would have a very good idea of what the deal could — and likely
should — be. But I don't make it that easy for them.
The students, armed with this (limited) information, then set about doing
the four things I think most good business lawyers routinely do:
help plan the deal, investigate the facts and the law as the deal develops, help negotiate it, and draft the paperwork, once there is agreement in principle.
Planning — Planning a transaction can mean many different
things. I don't expect students to have the expertise to plan the tax or
securities law details of any transaction, even one as straightforward as
the Either/Or capital formation. The only prerequisites for the workshop
are the business associations (corporations) course and at least one other
business law class, which may be commercial law, intellectual property law
or any number of other courses.
I do, however, want them to appreciate the ways that contract (and similar)
rights established today can significantly affect the parties' rights and
opportunities in the future. Sometimes, these are fairly basic things, like
thinking about the composition of the board, what the board can (and
cannot) do, the vote required to amend the charter, etc.
Sometimes, planning is more complex. For example, investors often want
protection in the event the company needs future rounds of financing (that
is, James Brown, the current investor, doesn't want a future investor to
get stock that dilutes the value of his stock). The students learn that
there are a number of contractual ways the investor can get this
protection, such as priority, antidilution formulas, veto power, conversion
ratios, etc. While I do not expect the students to become master venture
capital lawyers, these kinds of problems highlight the value (and
substance) of good business law planning.
Investigating — Investigating can mean several
different things. First, and as suggested above, the students have to do a
fair amount of talking among themselves just to figure out which end is up.
The setup I use — rich facts for the party, limited facts for the
party's lawyer — is central, because I want the students to learn
how important — and difficult — it can be to get information
in a deal. They have to learn not only what the other parties (and their
lawyers) want, but also what their counterpart (whether lawyer or client)
wants.
This also makes it easy to throw in realistic ethical issues for the
students to consider, which (if my experience is any indication) occur with
greater frequency in the real world than you'd think from most business law
classes. So, for example, I might have the student playing the founder's
lawyer learn in the background memo that he or she did some work for Aether
in the past. Who (if anyone) does the lawyer have to tell? What are the
consequences?
Similarly, I sometimes throw some issues into the discussion of the
founders' employment agreements with Aether (such as they may have a
noncompete, or a clause that says all inventions belong to Aether). Should
the student playing the founder tell his or her lawyer about this? What
happens in the negotiation when the Aether representative (Gilmore) —
who obviously also knows about the employment agreements — raises
these issues as bargaining points?
Although I do not view this as a research course, I do post for students
discussion materials on the relevant issues, including corporate
governance, covenants not to compete, licensing (for the Aether operating
system), the professional responsibility rules, etc. Students inevitably
end up doing some outside research, although they gradually see that they
already know most of what they need to know to plan and manage the
deal.
Negotiating — The point of all this planning and
investigating is, of course, to negotiate a deal. Having students act as
both lawyer and client helps them develop a sense of the unique issues that
arise in business transaction negotiations. It is, for example, a useful
way to show them how blurry the line is between "legal" and
"business" questions. Similarly, it helps (perhaps forces) them
to see the different perspectives from which they and their clients may be
negotiating. Those with money have very different concerns than do those
whose principal contribution will be their ideas and effort. The founders
need cash in a way that the investor, James Brown, does not necessarily
need this particular investment.
What happens if — as sometimes happens in the real world — a
party takes the "nuclear option": They walk away and say they
just can't do the deal? I've done different things about this. One has been
to force the students to do the deal, by saying, in effect, "no deal =
no grade." But this is somewhat artificial. Another way to handle it
is to the let the deal fall apart, but to salvage some educational value by
having the students focus on how and why they couldn't reach an agreement.
So, where a deal craters, each of the parties (and their lawyers) in that
team will have to explain — to me and the rest of the class —
what they wanted, what went wrong, and why a deal was not possible.
They would also have to draft a term sheet and one or two documents to
reflect the deal that they would have done, had they got what they wanted.
Among other things, this assures that students see there is no "easy
out" from the work they would have to do if they consummated a
deal.
Drafting — Once the students have a basic deal in
place, I ask them to draft a term sheet using a form I provide. The form
inevitably teaches them that they have left some details out of the
negotiations up to that point. So, more negotiations (and perhaps planning
and investigating) occur.
After they get to a term sheet, we review as a class the basic attributes
of the different deals the three teams develop. The point is not to reward
the most aggressive bargainers (or to embarrass those who did not get such
a good deal) but to learn to become comfortable talking about transactions
in public, and to show that different people can produce different deals on
the same basic sets of facts.
I then have them draft many of the basic operating documents (the charter,
bylaws, shareholders' agreement, license, legal opinion, etc) — also
from forms I provide. At this point, the lawyer/client distinction ends:
Everybody has to draft at least one or two forms.
I also have the students maintain "strategy journals." These are
informal memos they prepare both before negotiations (describing what they
want and how they will get it) and after the deal is done (describing what
they got, what worked, what didn't work, etc). At the end of the process,
the students have more or less negotiated and documented a basic capital
formation transaction, and dealt with some skills-building and ethical
issues along the way.
So far, I've described lots of practice, but not much theory. How do I
connect the workshop to some of the deeper points we try to make to our
students?
I organize much of my thinking about this around Professor Ronald Gilson's
important 1984 article, Value Creation By Lawyers. Here, Gilson, who
has a joint appointment at Stanford and Columbia law schools, asked a very
good question: How, if at all, do business lawyers add value to the
transactions they work on?
If you think about it for a minute, the answer isn't obvious. One party's
sharp lawyer may be able to take something away from a party represented by
a dullard. But this doesn't really create value, since the total
value of the deal hasn't gone up — it's gone down, because the
lawyers had to charge for this wealth transfer.
Gilson theorized that lawyers add value by performing two informational
functions that help the parties themselves figure out whether the deal is
priced properly (and, if not, to adjust the price and other terms): they
produce information, and they verify the information, by acting as
reputational intermediaries.
This dual vision of the business lawyer becomes a touchstone for the
simulation. In the planning and investigation phases, for example, it is
easy to stop the students at various points and ask whether they are (and
believe their counterparts to be) managing information in the ways Gilson
envisions. What information don't they want to produce, I ask, and why?
Conversely, have they learned what they need to know to do the deal? How do
they know when they know enough (admittedly, a somewhat metaphysical
question)?
I also try to get the students to think about some of the assumptions that
lie beneath their economic thinking. I will, for example, occasionally ask
the students to stop and reflect on their behavior in the negotiations, and
assess whether it is "rational" in an economic sense. If (as is
sometimes the case) it is not, I ask them to think about what else might be
motivating their behavior? To what extent can legal rules — whether
in contracts, statutes or cases — encourage or discourage various
behaviors? Is there something about the context of a deal that elicits
particular types of behavior? The simulation makes it possible to stop
occasionally and discuss these questions. This may be the real value of the
workshop, since this is something that you generally cannot do once you are
in practice.
When it has occurred at all, teaching transactional skills has often been
an ad hoc undertaking. On the one hand, academics in this context all too
often spout what Mark Sargent, Villanova Law School, has characterized as
"platitudes" about the virtues of clean living and right
thinking. On the other hand, there is the risk that UNLV law Professor
Robert Lawless recently observed on an ABA panel I organized, that teaching
business transactions skills will be nothing more than "Law in
Professor Lipson's Office." Teaching business law should, he correctly
noted, be more than a disjointed set of practice pointers from a teacher
who (most likely) no longer practices law.
This article has described what I hope is a middle path, one that attempts
to merge practice and theory in a way useful both to those who teach law
students how to practice business law and — perhaps more important
— to those who would hire them. While it appears that we are
teaching business transactions law more frequently, it is equally clear
that we are only just beginning to understand how to do so. The
workshop is, I hope, one step in that direction.
Lipson is an associate professor of law at Temple University - James E.
Beasley School of Law, in Philadelphia. His e-mail is
jonathan.lipson@temple.edu.
|
