Avery W. Katz: Dealing with the Incomplete Contract
Avery W. Katz, professor of law at Columbia Law School, tackles the conundrum of “incomplete contracts. The challenge? How can organisations fashion a contract that is both economically flexible enough for a business relationship to move forward efficiently, and legally secure enough to satisfy the parties’ legal departments.
I’ve written about incomplete contracts before – frequently highlighting the great work of Nobel laureate Oliver Williamson, who advised that organisations shift to “credible” contracts governed under a “flexible framework”.
While both men promote flexibility in a contract, as a legal scholar Katz brings a different – but very complementary – angle to Williamson’s work. I particularly like Katz’s article, “Contractual Incompleteness: A Transactional Perspective,” which approaches the subject from a broader public-private legal outlook than Williamson does. He talks about the business contract as a sort of “private lawmaking” between the parties engaged in economic activity, as opposed to the more policy-oriented approach, or “public lawmaking”, of contracting written with legal protections (i.e., public officials, courts) in mind.
Katz advocates that legal scholars focus more on addressing the contractual decisions of “private lawmakers (that is, transactional lawyers and their clients) and less on the decisions of public lawmakers (that is, courts and legislatures)”. Stated in another way (in Katz’ academic language of law-and-economics), “scholars should pay greater attention to considerations of private transactional efficiency as opposed to larger issues of social efficiency.”
Simply put, don’t wait for the courts to weigh in on a contract difficulty or dispute. The primary lesson from the literature on incomplete contracts stresses that courts are not in a position to effectively supervise many of the things that the parties know and do in negotiating and performing their agreement, Katz says. That’s because the contracting parties at the table have more information – and they have it early-on in the negotiating process – than courts do later on. He adds that from an economic viewpoint, maximising contractual value requires a proper balance, incentives and tradeoffs to achieve efficiencies. The parties are in a better position to negotiate those items – and thus avoid legal disputes – before the contract is locked in place.
Katz’s work clearly confirms the need for a methodology to address incomplete contracts. The University of Tennessee’s development of the Vested methodology points to the how of crafting a complex business agreement, which by nature will be incomplete. Understanding the nuances of how to best “architect” a strategic business deal is one reason the University of Tennessee created the “Certified Deal Architect” program, which is aimed at teaching the art and science of crafting an agreement in a highly dynamic environment where certain things (the impact of innovation and collaboration, for example) are unknown.