Category: Economic Perspectives

  • Do Judges Do Contract Interpretation Differently During Crisis Times?

    Posted by

    Mitu Gulati

    Scholars of constitutional law and judicial behavior have long conjectured that judges behave differently during times of crisis. In particular, the frequently made claim is that judges “rally around the flag”.  The classic example is that of judges being less willing to recognize civil rights during times of war (for discussions of this literature, see here, from Oren Gross and Fionnuala Aolain; and here, for an empirical analysis of the topic from Lee Epstein and co authors).

    But what about financial crises?  Are judges affected enough by big financial crises to change their behavior and, for example, rule more leniently for debtors who unexpectedly find themselves being foreclosed on? In a paper from a few years ago, Georg Vanberg and I hypothesized that a concern with needing to help save the US economy from the depression of the 1930s may have been part of the dynamic explaining the Supreme Court’s puzzling decision in the Gold Clause cases (here).

    A fascinating new paper from my colleague, Emily Strauss (here), analyzes this question in the context of the 2007-08 financial crisis.  Emily finds that lower courts judges, in a series of mortgage portfolio contracts cases during the crisis and in the half dozen years after, made decisions squarely at odds with the explicit language of the contracts in question.  From a pragmatic perspective, it is arguable that they had to; the contracts were basically unworkable otherwise.  But, as mentioned, this conflicted with the explicit language of the contracts. And judges, especially in New York, like to follow the strict language of the contracts (or so they say).   Then, and I think this is the most interesting bit of the story, Emily finds that, starting in roughly 2015 (and after the crisis looked to have passed), the judges change their tune and go back to their strict reading of the contract language.

    Here is Emily’s abstract that explains what happened better than I can:

    Why might judges interpret a boilerplate contractual clause to reach a result clearly at odds with its plain language? Though courts don’t acknowledge it, one reason might be economic crisis. Boilerplate provisions are pervasive, and enforcing some clauses as written might cause additional upheaval during a panic. Under such circumstances, particularly where other government interventions to shore up the market are exhausted, one can make a compelling argument that courts should interpret an agreement to help stabilize a situation threatening to spin out of control.  

    This Article argues that courts have in fact done this by engaging in “crisis construction.” Crisis construction refers to the act of interpreting contractual language in light of concurrent economic turmoil. In the aftermath of the financial crisis, trustees holding residential mortgage backed securities sued securities sponsors en masse on contracts warranting the quality of the mortgages sold to the trusts. These contracts almost universally contained provisions requiring sponsors to repurchase individual noncompliant loans on an individual basis. Nevertheless, court after court permitted trustees to prove their cases by sampling rather than forcing them to proceed on a loan by loan basis.

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  • My Favorite Contract Metaphors: Skeuomorphs, Sea Squirts, Barnacles and Black Holes

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    Mitu Gulati

    I love contract metaphors. I’m especially fond of metaphors for the phenomenon of antiquated and useless contract provisions that find a way to persist over the decades in boilerplate contracts.  Philip Wood, the legendary English lawyer, uses the metaphor of barnacles on a ship’s hull to describe how more and more of these useless provisions can accumulate over the years, eventually severely impacting the efficiency of the ship. If you like boats and hate barnacles (perhaps because one of your most hated chores in the summers was for you to attempt to scrape barnacles off the hull of your uncle’s fishing boat), this metaphor may work especially well for you (sorry, Uncle Marvin). Another favorite of mine, that does not bring up memories of unpleasant chores, is Doug Baird’s skeuomorph.  To quote Douglas, who in the course of his explaining why we should not be surprised that suboptimal contract terms both emerge and then persist, has some wonderful examples:

    To take a[n] . . .  example, maple syrup is often sold in a glass bottle with a small handle that serves no discernable utilitarian purpose. This is a relic of the time when maple syrup came in jugs and the handles were large enough to be useful. This phenomenon—of a product feature persisting when incorporated in a new environment in which it no longer serves a function—is well known and has a name: skeuomorph.

    Douglas goes on to explain that these skeuomorphs can bizarrely become desired features of the product in question (and remember he is drawing an analogy to contract drafting). He writes, while continuing with the maple syrup bottle example:

    Buyers of maple syrup want to see a small handle on the bottle. It serves no purpose, but it is what consumers have come to expect. Blue jeans are no longer made for working men who carry pocket watches, but buyers of blue jeans want a watch pocket all the same, even though they have no idea of the purpose it serves and have no use for it. Everyone expects Worcestershire Sauce bottles to come wrapped in paper even though the reason for doing this has long disappeared. Tagines took a particular shape for functional reasons when they were made of clay, and they retained this shape when made of aluminum even though there was no longer a functional reason for doing so. Skeuomorphs can be found everywhere on the “desktops” of personal computers

    In short, the idea that a clause could be added to a contract and remain there merely because everyone expected it to be there suggests nothing special about either pari passu clauses in particular or contract terms more generally. The same forces are at work as with ordinary product attributes. Crafting legal prose is hard, and few contracts are ever written from scratch. Lawyers almost always start with a template taken from someplace else. For this reason, those who draft contracts are likely to import features from earlier contracting environments, even when they serve no purpose, merely because they are familiar. To give another example involving financial instruments, the first railway bonds were based on real estate mortgages. They still bear some of the attributes of real estate mortgages, and not always for the better.

    If you like this topic, I recommend Douglas’ piece “Pari Passu Clauses and the Skeuomorph Problem in Contract Law” (you should of course ignore all the bits of this brilliant piece that are critical of my paper with Bob Scott and Steve Choi on Contractual Black Holes (yes, another metaphor I’m very fond of) that Douglas’ piece was a comment on).

    Last but not least is the Sea Squirt, a close cousin of the barnacle.  This one comes from M&A guru, Glenn West who was speaking on a panel at UT in 2018 on M&A Contracting.  The title of his presentation was: “Have Sea Squirts Invaded Your Contract?—Avoiding Mindless Use of So Called ‘Market’ Terms You May or May Not Understand”.  Below I’ve excerpted some priceless language from an August 2017 blog post by Glenn on MAC clauses in M&A agreements.  And yes, Glenn is talking about M&A contracts containing brainless bits of language; the contracts drafted by the most elite among all transactional lawyers.

    As an aside, there are a number of excellent recent papers arguing over how brainless M&A contracts are; see here (Anderson & Manns) and here (Coates, Palia & Wu).

    From Glenn’s blog post, here goes:

    The sea squirt is an animal that begins life with a brain and a tail.  Immediately after it is born, it uses its brain and tail to propel itself through the water until it finds some rockto attach itself.  Once it attaches itself to that rock it consumes its brain, absorbs its tail, and thereafter never moves again; it lives out its remaining life as a brainless water filter.

    Many of the standard terms of M&A agreements also began their existence with a brain—the brain of a smart lawyer who perceived an issue that needed to be addressed and drafted a clause to address it.  And then other smart lawyers recognized the value of that newly drafted clause, and adapted and improved it until it became a standard part of most M&A agreements.  But once that clause became attached to the “market” it became divorced from the brain or brains that created it, and soon everyone was using it regardless of whether they truly understood all the reasons that prompted its drafting.  Even worse, market attachment is so strong that even after a standard clause has been repeatedly interpreted by courts to have a meaning that differs from the meaning ascribed to that clause by those who purport to know but do not actual know its meaning (mindlessly using the now brainless clause), it continues to be used without modification.  Such is the case for many with the ubiquitous Material Adverse Change (“MAC”) or Material Adverse Effect (“MAE”) clause.

    My friend at UNC Chapel Hill, John Coyle, has an article coming out soon on “Contract as Swag”.  I’m eager to see how that metaphor will work. I like swag and I want learn how to get more of it.

  • Trump Wants to Buy Greenland for the U.S. – But Who Is the Relevant Seller?

    Posted by

    Mitu Gulati

    (This post draws from my prior work with Joseph Blocher and the many conversations we have had about this topic over the years; he bears no responsibility for errors and sarcasm)

    According to a flurry of news reports from the WSJ, CNN, Bloomberg, the NYT and many more, our eminent chief executive has an interest in the possibility of buying Greenland.  Most reactions to this news of DJT’s latest whim have boiled down to incredulity, while also generating a fair amount of mirth (see here, here and here).  What has interested us the most, though, are the articles that have concluded that the U.S. cannot buy Greenland. Bloomberg’s Quick Take ran the title – “Can Trump Actually Buy Greenland – The Short Answer is No”. 

    But is that really the case? The relevant international law seems to present no explicit barrier to nations buying and selling territory (here). Indeed, much of today’s United States was acquired through the purchase of territory.  The barrier that most commentators see as insurmountable is not legal, but rather the lack of a willing seller.  Maybe so.  But a handful of quotes from government officials and politicians in Denmark and a few from politicians in Greenland (see here and here) is not necessarily enough to conclude that this trade could never work.

    Before jumping to the foregoing conclusion, one needs to first ask how such a sale would work.

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  • Coyle on Studying the History of a Contract Provision

    Posted by

    Mitu Gulati

    The way many of us teach interpretation in Contract Law, there is little role for history (admittedly, this is just based on casual observation). The meaning of a clause is a function of the words that make up that clause.  The parties to the transaction are assumed to have drafted it to document the key aspects of their transaction, to balance risks and rewards blah blah.  If a dispute arises, we might have an argument as to whether a strict textualist reading of the words accurately represent what the parties really meant by them or whether we need to also examine the context of the relationship. What we do not ever do, however, is to delve into the history of the clause from before these parties contemplated using it – that is, of what prior drafters of the original versions of this clause might have meant in using it.

    The foregoing makes sense in a world in which the contracts for each deal are drafted from scratch. But does anyone draft contracts from scratch?  What if we live in a world where 99.9% of contracts are made up of provisions cut and paste from prior deals; provisions that are assumed to cover all the key contingencies, but not necessarily understood (or even read)? In this latter world, where there are lots of provisions that the parties to the transaction never fully focused on (let alone understood), might there be an argument – in cases where there are interpretive disputes — for the use of a contract provision’s history? Might that history not sometimes be more relevant than the non-understandings of the parties as to what they did or did not understand they were contracting for? (Among the few pieces that wrestle with this question are these two gems: Lee Buchheit's Contract Paleontology here and Mark Weidemaier's Indiana Jones: Contract Originalist here)

    I’m not sure what the answer to the foregoing question is. But it intrigues me.  And it connects to a wonderfully fresh new body of research in Contract Law where a number of scholars have been studying the production process for modern contracts.  The list of papers and scholars here is too long to do justice to and I’ll just end up making mistakes if I try to do a list.  But what unites this group of contract scholars is that for them it isn’t enough to assume that contracts show up fully formed at the time of a deal, purely the product of the brilliant minds of the deal makers who anticipate nearly every possible contingency at the start.  Instead, understanding what provisions show up in a contract, and in what formulation, requires understanding the contract production process. (Barak Richman's delightful "Contracts Meet Henry Ford" (here) is, to my mind, foundational).

    It is perhaps too early to tell whether this research will catch on and revolutionize contract law. I hope it does, but I’m biased.

    One of my favorite papers in this new body of contract scholarship showed up recently on ssrn. It is John Coyle’s “A History of the Choice-of-Law Clause” (here). I have rarely found a piece of legal scholarship so compelling.  The paper is not only a model of clarity in terms of the writing, but it is brave. It is completely unapologetic in not only taking on an entirely new mode of research (a painstaking documentation of the historical evolution of the most important terms in any and every contract), but in coming up with a cool and innovative research technique for unpacking that history (this project would have been impossible to do without that innovation).

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  • Ramming Bow Contracts

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    Mitu Gulati

    Have you heard of Ramming Bows? Or did you know that they describe a category of boilerplate contract provisions?  Until a couple of weeks ago, I had not either.  That was when I came across Glenn West’s two delightful blog posts at the Weil Gotshal & Manges site (here and here). Glenn is a senior partner in the Private Equity/M&A practice at Weil. And in his spare time, he writes wonderfully witty blog posts and articles about wide range of legal issues; many of which are about the bizarre world of sophisticated boilerplate contracting.  Even if you have no interest in contract law, let alone boilerplate contracts, I suspect that you will enjoy his writing.  It is insightful about the way in which contracts get produced and evolve in the real world and, even better, is funny.

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  • Yannis Manuelides Paper on the Limits of the “Local Law Advantage” in Eurozone Sovereign Bonds

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    Mitu Gulati

    Sovereign debt guru and Allen & Overy partner, Yannis Manuelides has a new paper (here) out on the “local law advantage” in Euro area sovereign bonds.  This paper, along with Mark Weidemaier’s paper from the beginning of the summer (here – and a prior creditslips discussion about it here), helps shed light the thorny question of which European local-law sovereign bonds should be valued more by investors: Ones with CACs or ones without them.  Given that there are billions of euros worth of these bonds with and without CACs being traded every day, one might have thought that there would be clear answers to these questions from the issuing authorities themselves.  There are not.  Further, some of the folks at the various government debt offices take the bizarre (to me) view that answering this question might somehow scare the market.

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  • The Mad Mad World of “No Contest” Provisions in Wills

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    Mitu Gulati

    It has been almost twenty-five years since I got hooked on the puzzle of why boilerplate financial contracts, even among the most sophisticated parties, have inefficient terms. Steve Choi and I were taking Marcel Kahan’s Corporate Bond class and we couldn’t understand why the classical model with its highly informed repeat players (with everyone hiring expensive lawyers) wasn’t working to produce the optimal package of contract terms. Marcel presented a very coherent set of explanations for this phenomenon of contract stickiness having to do primarily with network and learning externalities.  And under that model, it was plausible to have equilibria where sophisticated commercial parties and their lawyers could know that they had suboptimal contract terms and yet be somehow unable to change them easily (thereby creating the phenomenon of “sticky” contracts).  Marcel though repeatedly emphasized to us that he had but scratched the surface of a topic worthy of much more investigation (for the classic Kahan & Klausner (1997) paper and its equally wonderful predecessor by Goetz & Scott (1985), see here and here).

    Over the past two decades, since the publication of Kahan & Klausner’s sticky boilerplate paper, there have been a number of advances to our thinking about the phenomenon of sticky boilerplate. Most of them, however, have been focused on the worlds of mass market contracts of sophisticated finance or transactions where one of the sides to the transaction is a big repeat player (corporate bonds, sovereign bonds, M&A contracts, insurance). 

    A wonderful new boilerplate paper though takes on an altogether unexpected area where I had always thought of the contract-type instruments as being highly tailored: that of Wills. The paper is “Boilerplate No Contest Clauses” posted about a month ago by David Horton (UC Davis) and Reid Weisbord (Rutgers). 

    The paper identifies a persistent inefficiency in Wills – an area that I suspect most contract boilerplate scholars are utterly unaware to. That itself is interesting. But this paper goes beyond the traditional boilerplate contract scholarship which, as noted, identified the stickiness problem in mass market contracts.  Wills, as I understand the story that David and Reid tell, tend to always have both an element of tailoring for the individual client and an element of blind unthinking cutting and pasting from prior standard forms. What David and Reid show beautifully in their paper is that the boilerplate portion of the contract (and specifically, the “No Contest” provision) can often undermine the tailored portion that more specifically reflects the intent of the party making the Will.

    For those not familiar with these clauses, the following is typical:

    If any beneficiary under this Will in any manner, directly or indirectly, contests or attacks this Will or any of its provisions, any share of interest in my estate given to that contesting beneficiary under this Will is revoked . . . . “

    Basically, this says: Don’t you dare challenge this Will. If you do, you might lose everything.

    Problem is, as David and Reid explain, that there are situations where complications arise with the Will and someone has to go to court to get the complications resolved. That then presents the risk that some dastardly beneficiary will claim that the No Contest clause has been triggered vis-à-vis the innocent beneficiary who is just trying to solve a problem with the Will that the testator didn’t take into account. End result: The intentions of the testator are undermined. Even if the court ultimately tosses the challenges being made on the basis of the No Contest clause, time and money gets wasted.

    Why does this clause persist?  The answer given by Reid and David is straightforward: These clauses are cut and paste from prior Wills without thought. They are part of the boilerplate that neither the lawyers nor their clients pay any attention to.  But why not?  The standard explanations from the boilerplate literature such as network/learning externalities, first mover disadvantages, negative signaling, status quo bias, inadequate litigation, etc., do not seem to apply particularly well.  Nor do explanations about big firms who are repeat players exploiting innocent customers who are one shot players.  So, given that the standard explanations do not work, why is the subset of the market for legal services not working?  Are the lawyers not being paid enough to read the boilerplate portions of the Wills and think through the contingencies?  (Best I can tell, the lawyers do actually understand the problem, since there has been lots of litigation over these types of clauses).

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  • Lowdermilk on Family Farmers in Financial Trouble – new paper!

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    Melissa Jacoby

    Jamey Mavis Lowdermilk has just posted an article of interest to Credit Slips readers — lawyers, judges, journalists, policymakers, and more. The article uses a case study of a chapter 12 family farm bankruptcy in North Carolina to ask bigger questions about farming finances and how public policy on farming is set. Extending the early work of now-Representative Katie Porter, Lowdermilk brings her own perspective and expertise to this topic. Before law school, Lowdermilk obtained a masters degree in applied economics and statistics with a specific interest in agriculture as well as rural development, and held a variety of positions related to farms, forestry, and credit. During law school, she started this chapter 12 project in my advanced bankruptcy seminar. After law school, Lowdermilk continued to work on the project and revise the paper for publication as a law review article. Several wonderful bankruptcy judges graciously offered feedback as her first footnote documents. Please check it out!

  • Deleveraging Is Over

    Posted by

    Alan White

    An unsustainable run-up in consumer housing debt and other debt was a fundamental structural cause of the 2008 global financial cScreen Shot 2019-02-26 at 11.59.42 AMrisis. Following four years of painfully slow decline, total U.S. consumer debt has now risen back above its 2008 peak, with the growth led by student loan and auto loan debt. Mortgages outstanding are not quite at their 2008 levels, but student loan and auto loan growth more than makes up for the modest home loan deleveraging. Americans are back up to their eyeballs in debt, but now some of the debt burden has shifted from baby boomers to millennials. While the cost of health care may be a key electoral issue for the over-50 crowd, under-40s will be listening for policymakers to offer solutions on student loans.

  • New (From the Archives) Paper on Determinants of Personal Bankruptcy

    Posted by

    Melissa Jacoby

    This working paper is a longitudinal empirical study of lower-income homeowners, including a subset of bankruptcy filers, produced with an interdisciplinary team of cross-campus colleagues, including Professor Roberto Quercia, director of UNC's Center for Community Capital. We just posted this version on SSRN for the first time yesterday in light of continued interest in its questions and findings. The abstract does not give too much detail (see the paper for that), but here it is:

    Personal Bankruptcy Decisions Before and After Bankruptcy Reform

    Abstract

    We examine the personal bankruptcy decisions of lower-income homeowners before and after the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Econometric studies suggest that personal bankruptcy is explained by financial gain rather than adverse events, but data constraints have hindered tests of the adverse events hypothesis. Using household level panel data and controlling for the financial benefit of filing, we find that stressors related to cash flow, unexpected expenses, unemployment, health insurance coverage, medical bills, and mortgage delinquencies predict bankruptcy filings a year later. At the federal level, the 2005 Bankruptcy Reform explains a decrease in filings over time in counties that experienced lower filing rates.