|The design of legal products
The commercial imperative is the cold, hard bedrock of commercial reality which underpins every contract, every transaction, every thing about your relationship with your client, and which your client’s lawyer is certain to not understand.
If she does understand it, she will profess not to care about it, will claim it is beside the point, and insist on three acres of pointless legal mulch avoiding all of the paranoid doubts that she can coax out of the darkened deeper recesses of her cranium. This is entertaining — for her — but a ghastly waste of time for the better interests of commerce in the abstract, personified by you.
The commercial imperative is not beside the point. It is the point. It is, in the long run — when we personifiers of the better interests of commerce have been shunted from our mortal coil — the only point.
Why merchants transact
Every merchant enters into a contract with a commercial aspiration; that all going well, that contract will yield some kind of benefit. That is it; that is the sine qua non of entering into any commercial contract: you hope that, over time, it will help you will make money. Lots of money. If it does not, it is a dud. You should dispense with it.
Assuming you have not, we can assume your contract is yielding you a benefit. Let’s call that benefit “X”.
X is made of three components:
- Historical X: “Historical X” is the benefit you have already extracted from this contract. It will give you a comfy feeling, it will call to remind the chalet in France that you bought with it, and it may help project your expected benefit for the future, but for all other purposes it is meaningless. It is in that foreign country called the past.
- Current X: “Current X” is the as-yet-unrealised benefit you expect from current transactions and those you can realistically expect during the no-fault notice period of the contract. Think about this as “unbilled work in progress”. This is a benefit you can safely say you will earn, but have not yet. It is exciting — you can almost touch it! — but, compared with Future X, it will amount to bugger-all.
- Future X: “Future X” is the benefit you can expect from contracts throughout the remainder of your relationship, if you both remain solvent and on good terms. Future X is much less certain, but it is much bigger. Future X is the golden prize. It is why you show up for work. It is your unrealised potential.
You are short an option on Future X
Now. Look at the prospects for each type of X.
- Historical X is in the bank, and probably spent. Thanks for the memories.
- Current X, meagre though it is, is as good as being in the bank.
- But you are short an option on Future X.
Why are you short an option on Future X? Because you are not entitled to it. You have to persuade your client to give it to you. You cannot stop your client terminating the contract if it wants to. Your client is free to walk away and take all that lovely, juicy Future X with it, and give it to someone else. Since Future X is so much bigger than Current X, you should apply every fibre of your being to giving your client no earthly reason to take its business elsewhere.
Now, during your relationship, you may, if the fancy takes you, indulge in what we might call “dick moves”. You might seek to exploit the literal wording of a contract even though you both know your commercial intention in entering it was something else.
There are (at least) two kinds of dick moves:
- Mistrades: Dick moves that arise from a misconception between the parties on a transaction: your expectation and your client’s about the commercial intention were different. Cheapest to deliver options in credit derivatives are this kind of dick move. Your client sees a Triple A rating eligibility criteria — woo hoo! — and sees in it impeachable credit. You look at it and see some overworked grad at Moody’s who doesn’t understand correlation risk and has handed you an opportunity to dump the crappiest, most poorly risked, implausibly rated bonds that you can find into your portfolio.
- “Tent-peg” mistrades: A broker servicing its client is somewhat short an option — the one that arises because the client is always right — and as a consequence will write in ostensibly outrageous legal protections (indemnities, hold harmlesses and so on) which it never intends to use by way of defensive strategy to spike the client’s temptation to take advantage of its supine broker and pull a dick move. It is, I suppose, always possible a broker would opportunistically exploit a tent-peg term to rip a client’s face off but why on earth would a sane, well directed broker, who understands the commercial imperative, do that?
At the start of your relationship, you won’t know the value of the three Xs. That is when you, your counterparty, and your respective battalions of lawyers will go through the unedifying ritual of contract negotiation. The legal eagles will agonise four weeks on the potential import of legal terms. “Does under really mean the same thing as pursuant to and in accordance with?” This kind of thing. It’s awesome fun. Most of the arguments will concern circumstances which are almost certain never to occur and, if they do, will be utterly destructive of Future X in any case. The insolvency of the parties, for example. It is all very tedious, but those of a certain disposition seem to enjoy it. We write about them a lot on this site.
In any case arguing about these semantics will delay the start of the Historical X period.
- By terminating it on notice, rather than by exploiting legal drafting, needless to say.
- Being the earliest point at which your counterparty could freely terminate its obligations under the contract.
- As Criswell famously said, “we are all interested in the future, for that is where you and I are going to spend the rest of our lives.”
- In fairness, your client might pull the odd dick move, too. Especially if it is a hedge fund. For certain kinds of hedge funds, dick moves are part of the business model.
- Once upon a time there were plenty. They all wound up in CDO3 deals.