The Cost of Legalese: A “Lawyer Tax” on Doing Business

August 23, 2018 legalese

Author: Kingsley Martin

Contracts are the language of business; they document business relationships. Their purpose is not only to record the terms of a business agreement in a legally enforceable manner but also to set out the parties’ rights and obligations under the contract and govern any disputes that may arise. Unfortunately, many businesspeople (and some of their lawyers) confess that they cannot understand the legalistic language used in many contracts they sign or administer. As stated in an earlier post, Legalese has become The Business Scourge of Our Time.

The process of generating these unwieldy contracts is usually the following. The lawyers charged with preparing the document find prior, similar contracts, all heavily laden with legalese, and then copy and paste blocks of that text into a new document. The result is something that is not only difficult to understand but also, as we will show below, wastes the time and money of the businesses they are trying to help.

The benefits of simplified and streamlined contracts are clearly understood: they reduce contract negotiation times and minimize disputes. Plain English agreements recently introduced at GE Aviation take “a whopping 60% less time to negotiate than their previous legalese-laden versions did. Some customers have even signed plain-language contracts without a single change. Customer feedback has been universally positive, and there hasn’t been a single customer dispute over the wording of a plain-language contract.” Why It’s Time to Kill Legalese, Shawn Burton, Harvard Business Review, 2018.

It is hard work to reduce long, legalistic contracts into short, understandable documents written in plain language. But in cases where a business executes one or more contract types multiple times a year, there are major benefits to doing this work, particularly when using the technological tools now available to expedite the process.

Reasons Given for Using Legalese

Lawyers give many reasons for continuing to use legalese:

  • “It’s always been done this way.” In this view, there is no good reason to change old-style language [lawyers tend to resist change.]
  • “This language has been tested by the courts.” [If this language were indeed certain, parties would not need to keep going to court to dispute what it actually means.]
  • Traditional language “works.” [See comment immediately above.]
  • Legal language (“Know all men by these presents,” “In witness whereof,” etc.) gives the contract a sense of gravitas. [Contract gravitas is of no quantifiable benefit to any business.]
  • Using complex language is the only way to handle complex fact situations. [Insurance is often available to protect businesses against identifiable risks.]

Among other things, the fact that various companies have been using plain language contracts for several decades 1—and that legislation sometimes mandates plain language in certain consumer transactions—disproves these assertions.

There are at least two downsides to businesses continuing to use legalistic contracts. First, it results in documents that are very difficult to understand. Second, the time involved in having lawyers prepare these contracts results in what is essentially a hidden tax on transactions.

  1. Poor Readability. Using legalistic language results in contracts that are hard to read and understand. B2B contracts should target a readability score such that the language can be understood by someone with a college education. However, most contracts written by a law firm have scores that would require many years of post-graduate training to understand. The bottom line: legal agreements are rarely easy to read and understand for those they are intended to benefit, namely businesspeople.
  2. Cost of Legalese: A Hidden Tax on Transactions
    • Time. When lawyers for one party draft language that attempts to address every possible contingency, and then negotiate that language with lawyers for the other party, the time needed to arrive at a signed agreement increases significantly, which results in higher legal costs. Businesses rarely track the time needed for lawyers to carry out these tasks.
    • Direct cost of preparation and negotiation. There is a quantifiable cost to businesses in having lawyers prepare and/or review contracts, namely the dollar value of the resulting legal fees as a percentage of the value of the agreement. This calculation can easily be done for most types of contracts, such as contracts of purchase and sale or contracts for services. The more interesting—but as yet not available—is an analysis to calculate the contract value ratio to gauge suitability for purpose. The old adage that “no-one gets fired for hiring IBM” no longer holds true as businesses must also evaluate costs relative to risks.The more lawyer time that is spent on contracting and contract negotiation, the greater the “lawyer tax” on the transaction. As a general rule, for contracts with a quantifiable value, negotiation time ranges from 2% to 4% of the contract value. The relative percentage increases for lower value agreements, which are typically also executed more frequently than higher value agreements. When a business has lawyers negotiate a large number of contracts, this “lawyer tax” can constitute a significant sum.The better, and cheaper, option is to use short, plain language contracts and to buy insurance to cover known contract risks, for a much lower cost than that of the “lawyer tax.”
    • Indirect “uncertainty tax.” Unclear, uncertain, and complex language may later have to be litigated simply because the contract was not drafted in a clear, understandable manner. This uncertainty risk is well known to insurance companies and can be measured (as will be detailed in a later post) by variance from expected outcomes.
    • Indirect lost opportunity cost. Businesses suffer lost revenue from the delay in realizing the benefits of a signed contract. For example, the cost of a three-month delay in executing a $1 million contract over a five-year contract lifecycle is more than $50,000:

      Three months’ interest (@cost of capital2: 12%) = $30,000
      Future value of that amount over five years = $52,870

      Most businesses are unaware of the potential revenue gains available to them simply from getting their contracts signed more quickly.

Simplification: The Preferred Approach

Businesses should generally opt for contracts with language that is clear, plain, and simple. GE Aviation (referenced above) is not the only company to reap significant savings from converting legalistic contracts to plain language.

This is not, however, always the optimal approach. It would not be wise, for example, to use a highly simplified contract for a multi-million-dollar software development agreement. But in the large majority of cases, particularly where a business frequently negotiates and signs a particular type of contract, a simple form of agreement, along with any necessary insurance to cover identified risks, will suffice.

Contract-Type Scenarios

This chart summarizes the scenarios for using different contract types:

Contract type Description Comment Contract to use
Commodity Acquisitions Where goods and services are commercially available, fungible, and replaceable It is estimated that 40% of B2C and B2B contracts fall into this category Use a highly streamlined contract (1 to 2 pages)
Specialized or Customized Acquisitions Where goods or services are commercially available but may have limited sourcing or need to be tailored to particular needs It is estimated that 50% of B2B contracts fall into this category. Use a template, customized from a standardized clause library.
Innovative Acquisitions For goods and services that have yet to be commercially developed It is estimated that the remaining 10% of B2B contracts fall into this category. If necessary, customize and wordsmith the contract documents, but draft clearly and without jargon.

Conclusion

Given the significant volume and value of contracts executed each day around the globe, the economic benefits of contract simplification can be measured in the billions of dollars, yuan, yen, pounds, and francs.

  1. See, Plain Language Contracts On The Rise, Forbes, March 18, 2018.
  2. See, http://www.investinganswers.com/financial-dictionary/stock-valuation/cost-capital-112

Sign up for our blog.

Stay up to date with all things Akorda.

Show Buttons
Hide Buttons