Explaining the Value of Transactional Lawyering (Steven L. Schwarcz)

Transactional lawyers add value by (1) minimizing the potential for ex post litigation; (2) reducing transaction costs; (3) reducing regulatory costs37; (4) acting as reputational intermediaries; (5) providing client privilege and confidentiality; (6) creating economies of scope.

Each of these hypotheses is further explained below. 1. The hypothesis that transactional lawyers add value by minimizing the potential for ex post litigation. This hypothesis predicts that lawyers add value to transactions by anticipating and minimizing the likelihood that failure of the transaction will result in litigation. 2. The hypothesis that transactional lawyers add value by reducing transaction costs. Under this hypothesis, transactional lawyers reduce certain transaction costs, thereby increasing the size of the pie for all parties. They reduce moral hazard, for example, by drafting transaction documents and agreements to eliminate adverse actions due to changes in incentives. Thus, if the purchase price of a capital asset in an M&A transaction is adjusted based on buyer’s revenues in the year following the sale, the seller’s transactional lawyer could negotiate and draft the contract so as to eliminate the buyer’s incentive to increase current costs (and thereby adjust the purchase price downward). This hypothesis also predicts that transactional lawyers reduce agency costs by implicitly monitoring (as independent advocates for their client’s position) that their client’s officers act on the client’s behalf and that they effectively reduce asymmetric information by giving legal opinions. Although complying with law might be broadly viewed as a cost of engaging in a transaction, the relevant literature does not generally include legal compliance as a transaction cost.42 It is therefore discussed as a separate hypothesis, below. 3. The hypothesis that transactional lawyers add value by reducing regulatory costs. In its narrow form, this hypothesis predicts that transactional lawyers add value by understanding their clients’ regulatory concerns, thereby being able to negotiate deals without compromising regulatory compliance.43 This “client-regulatory” legal work involves understanding the law and regulation that bind the client, qua client. Because most clients, just like most companies, are not highly regulated (if regulated at all),44 this article posits a broader hypothesis, distinguishing between client-regulatory legal work and “transaction-regulatory” legal work. Transaction-regulatory legal work involves understanding the law and regulation that govern the particular type of transaction, irrespective of the regulatory concerns of the client engaging in the transaction. As an example of this distinction, consider a typical legal opinion, concluding (among other things) that an agreement is enforceable according to its terms and that performance thereof would not violate law. In rendering this opinion, transactional counsel would be performing client-regulatory legal work to the extent counsel’s conclusion goes to no violation of law, and would be performing transaction-regulatory legal work to the extent the conclusion goes to enforceability of the agreement qua agreement. 4. The hypothesis that transactional lawyers add value by acting as reputational intermediaries. Under this hypothesis, as repeat players in the transactional world, transactional lawyers add value by renting their good reputation to clients. If, for example, a particular law firm is well known for representing underwriters selling securities, the hypothesis predicts that underwriter-clients, by using that firm, signal a measure of reliability and soundness to potential investors in those securities. The high-reputation law firm not only has expertise but, more importantly, bonds itself to good performance; it would lose at least part of its reputation if it failed to perform well. In this regard, reputation appears to be a more effective “bond” than liability because professional negligence is hard to prove and, when proved, is usually covered by insurance. The hypothesis also predicts that hiring a high-reputation law firm adds even greater value when the client does not already have a high reputation (e.g., is not a repeat player) in a type of transaction. This hypothesis appears to be the most agreed upon scholarly theory of the value added by transactional lawyers. 5. The hypothesis that transactional lawyers add value by providing client privilege and confidentiality. According to this hypothesis, lawyers add value by providing clients with a measure of privilege and confidentiality. Clients gain these protections through the attorney-client privilege: a lawyer’s work product, including correspondence with clients in preparing for a deal, may be privileged under applicable state law.Thus, a client may be able to communicate through its lawyers without revealing confidential matters to opposing parties. 6. The hypothesis that transactional lawyers add value by creating economies of scope. Economies of scope represent the savings resulting from having the same investment support multiple profitable activities less expensively in combination than separately. Because transactional lawyers already play a legal role in transactions, this hypothesis predicts that “economies of scope should give them an advantage in performing the [non-legal] aspects of transaction structuring as well.”

According to this hypothesis, non-legal jobs include negotiation and drafting of deal documentation, identifying differences in valuation, reducing transaction costs, and engaging in due diligence. This hypothesis predicts, for example, that although a non-lawyer scrivener could instead negotiate and draft deal documentation, a lawyer would still be needed to review the documentation from a legal standpoint. Having the reviewing lawyer also do the negotiation and drafting creates the economy of scope. Transactional lawyers can and do create economies of scale, such as by counseling multiple transactions of a given type, thereby apportioning the cost of gaining experience and expertise. Although that adds value, it is not value that is unique to transactional lawyering: any party who advises on multiple transactions of a given type could add similar value. For that reason, and since economies of scale are not singled out in the literature as a source of transactional lawyer value, this article does not separately test whether transactional lawyers add value by creating economies of scale. To some extent, however, that value is implicit in certain of this article’s other hypotheses. For example, transactional lawyers should better perform transaction-regulatory legal work by counseling multiple transactions, should better perform client-regulatory legal work by counseling multiple clients subject to the same regulatory framework, and should be better reputational intermediaries by engaging in repeat transactions. More marginal ways in which transactional lawyers may add value. In addition to the foregoing hypotheses, transactional lawyers may add value in more marginal ways. From a behavioral-psychology standpoint, for example, transactional lawyers—by training if not also by the temperament of many who go into the legal profession, especially those who avoid being litigators—are likely to be more risk averse than their business clients. These lawyers therefore may provide a sounding board to help clients balance risk-prone ideas. Transactional lawyers also might add value by enhancing the perception of social ordering: society has a fundamental need for order, and lawyers are the priests who provide the order through law, granting confidence and authority to transactions. Transactional lawyers additionally can add value to the client by providing a measure of risk-shifting, in that the client might have a claim against the lawyer if the transaction results in losses. Any such claim would succeed, however, only if the lawyer was negligent in failing to protect against the losses, and clients should be able to insure more efficiently in other ways against bad outcomes. Furthermore, this reallocation in overall value is not the type of value on which this article focuses.