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Mitu Gulati and Robert E. Scott’s new book, The Three and a Half Minute Transaction: Boilerplate and the Limits of Contract Design examines the pari passu clause, a clause designed to ensure a debtor’s creditors rank against each other equally. It asks why a standard clause in cross-border financial contracts remained in sovereign debt contracts after a well-known but minor judgment in a Belgian court suggested that the clause should be amended or removed. The book reveals that the majority of practitioners designing and drafting these contracts did not have a coherent and consistent explanation of the origin, purpose, or meaning of the term in sovereign debt contracts. How can it be that sophisticated legal practitioners can put forward contracts, worth millions or even billions of dollars, where they do not understand a term common to, and prominent in, the contract? And once a court decision, albeit an ‘unreliable’ ex parte Belgian decision, threatens to undermine received wisdom on the overall effect of those sovereign debt contracts, posing not insignificant risk that the clauses will be litigated, how is it that these terms remain largely unaltered? Moreover, why is the clause not removed if, as many seem to think, it performs no discernible and certainly no predictable function in the sovereign debt arrangements?

These are some of the fascinating questions explored in Gulati and Scott’s excellent book, The Three and a Half Minute Transaction. Part empirical project, part theoretical exposition of securities law, and part detective novel reaching back to Bolivia in 1870, it is a highly readable and nuanced account of how elite lawyers approach the drafting of sovereign debt contracts. The account is theoretically and empirically rich. Its conclusion is that modern legal practice poses significant challenges to the evolution of professional practice. It also raises questions about whether and how systemisation works. Systemisation is the idea that legal practice can be disaggregated into component parts and automated through processes (checklists, software and the like). As a favourite theme of innovators keen on developing legal practice beyond the inefficient artisan model— the book serves as a reminder as to how systemisation needs to cope with the complexity and stickiness of clients and markets.

As such, the book raises important challenges to the old guard (largely now the professional bodies) that holds to the notion of bespoke professional service delivering excellence. The book suggests that in sovereign debt contracts that it does not. It also challenges the new guard, those advocating disruptive innovation, such as Richard Susskind and Daniel Katz, to suggest how systems will overcome complexity and stickiness as a social phenomena embedded within client networks.

The story this book tells begins with the pari passu clause. We are told that the clause has been a feature of sovereign debt contracts for many years. As part of the contract’s boilerplate, such clauses are assumed to have survived and developed by reason of their utility and efficiency. An evolutionary theory of contracts casts out bad clauses while simultaneously ensuring that good clauses survive. The authors’ carefully critique the idea that there is a process of intelligent design at work. There are charismatic elder statesmen who do research, theorise, and innovate in contractual design in some of the firms under consideration, but the authors point out that these Wise Men—they are all men—are dying out and are apparently not being replaced. Additionally, these Wise Men have not used their influence to resolve the pari passu problem.

Instead, the story that we hear is of how large firms rely on precedents and computerised systems, which generate “horseshoe” contracts—standard forms that come close to a client’s needs and can be marked up with minimal effort to meet those needs. Lawyers are required to draft these contracts quickly, and—so the lawyers say—have no incentive under hourly billing and increased client pressures to conduct the research needed to replace the flawed clauses. More worryingly still, such lawyers miss out on the once traditional practice of having a partner explain mark ups and amendments of agreements. They do not learn the effect of the agreements they are working on. As one mid-level associate told the researchers:

Most of what we mark up and send round, we don’t understand at all.

The story is of agreements that are both mechanical and resistant to change. There are a variety of “herd instinct” biases that inhibit lawyers from suggesting changes. Changes require time and money to be invested. Conservative clients are said to resist them. Change brings with it risk; if a contract is changed there is a risk of unsettling the wisdom accumulated over years of practice.

A strength of the book is that it is simultaneously possible to both understand and be alarmed by the way in which such explanations are offered by practitioners without any coherent justification for their approach winning out. Particularly alarming is that the elder statesmen within elite firms specializing in securities law offer explanations as to the function of pari passu clauses that are contradictory (i.e., different lawyers do not agree with each other) and are—in Gulati and Scott’s view—often indefensible. Their views and continuing practice in the area appear to be ignorant of the major court decisions and policy stances bearing on the continuing use of pari passu clauses. The authors never explicitly state as such, but there is an alarming sense that—as regards this particular clause—the practitioners are simply making up explanations for their actions, or more often inactions, as they go. Far from the expert and forensic professional judgment being applied to the design of such high value contracts, habit and the rituals of practice replace deliberate thought.

Thus, the study quotes one practitioner saying:

why a standard clause in cross-border financial contracts, now . . . one that a junior associate can go to and plug the relevant parameters into—you know, type of issuance, type of issuer, which side we are representing, etc.—and the computer generates a standard contract. The firm spent [a large amount] on putting together this system. Associates can now produce a contract for one of these deals in three and a half minutes. This is the future of contracting in these markets.

The benefit of systems is that they produce predictability and uniformity. Gulati and Scott’s book thoughtfully develops an account of the benefits of predictability. Complex systems benefit from predictability. Clients prefer it. Changes in standard documents may breed suspicion and create negotiating costs. Thus, there is benefit in inertia within any particular system. So, when in Elliot v Peru an Belgian judge interpreted a pari passu clause in an unusual way, one might not be that surprised that law firms did not quickly change their sovereign debt agreements. Yet, clauses that once seemed obscure and harmless suddenly posed a litigation risk. Why did firms decide to do nothing about their pari passu clauses?

The book carefully dissects the reasons for not changing sovereign debt agreements in light of Elliot v. Peru and finds them wanting. Although, the rationale that most often appears to surface has a plausible ring to it: the transactional lawyers were worried about prejudicing future litigation. If you change a clause in response to a potential litigation threat, then it may be seen as an admission of doubt about the original clause. The problem with this argument is twofold. First, the opposite is as likely: if a court—even an obscure Belgian court—has interpreted a clause in a particular way and you have not taken prudent steps to clarify the meaning of the clause in the light of such a decision, then you might be taken to have accepted the Belgian court’s interpretation. Second, and here the book is worryingly convincing, the firms need to be able to show that the clause used has a plausible meaning, which they cannot do because the firms do not understand the meaning of the clause.

For the new guard the challenge that this poses is that a systemised, efficient contract process needs to have someone in full and proper control of the system. This book suggests that the operation of client markets and organisational theory both suggest that systems can become overly fixed—sclerotic and harmful to client interests. For me, one of the telling critiques made by the book is the way in which lawyers within the study had both diagnosed the underlying problem (firms drive lawyers only to do work for which they can bill) and sought to distance themselves from it. One partner, for example, bemoans the costs of associates: If they were paid less, his argument goes, the firms might be able to train them more. This begs the question, why do they need to compete for associates in a market that rewards newly qualified lawyers with high salaries if those same lawyers are drafting contracts that they (and their supervisors) do not understand? Moreover, how are their elders and betters going to train them, anyway, if they don’t understand these contracts either?

Of course, this may be going a little far. We are only talking about one clause in one type of contract. Other types of contracts and practice may be different. For the book to be able to go both deep and wide in its data collection, it had to concentrate on one type of contract. There is also the possibility that lawyers ignored the Belgian court decision because it was wrong, as most practitioners agreed it was, and irrelevant. The authors point out that the problem with this interpretation is that two subsequent cases suggest that other judges may be inclined to agree with the Belgian judge, or at least go some way towards agreeing. Both the Greek debt crisis and an Argentinian case suggested there is unpredictable life in the pari passu clause that practitioners would have been wise to address when Elliot suggested a problem. It looks possible that when securities lawyers offered the explanation that the Belgian decision was wildly wide of the mark, they let complacency and the habits of practice get the better of them.



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Cite as: Richard Moorhead, It’s the System, Stupid?, JOTWELL (November 22, 2013) (reviewing Mitu Gulati & Robert E. Scott, The Three and a Half Minute Transaction: Boilerplate and the Limits of Contract Design (2012)),