Abstract

http://ssrn.com/abstract=1372856
 
 

Citations (1)



 
 

Footnotes (150)



 


 



Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions


Albert H. Choi


University of Virginia School of Law

George G. Triantis


Stanford Law School

April 3, 2009

Yale Law Journal, Vol. 119, 2010
Virginia Law and Economics Research Paper No. 2009-16

Abstract:     
The unprecedented and unanticipated economic and financial shocks of the past couple of years have led parties to look for contractual escapes from deals. Some parties exercise options embedded in their contracts by paying liquidated damages or cancellation fees. Others invoke excuse provisions such as force majeure, material adverse change or market-out clauses, to terminate at no cost. Under either set of circumstances, disputes arise, are litigated and typically settled either by a termination of the deals or adjustments to their terms. The increased attention paid to these provisions has illuminated the vague language with which these options and excuses are framed, and their uncertain interpretation. One instance in which this has been noted is the common use of material adverse event or change (MAE/MAC) conditions in corporate acquisition contracts.

As the current crisis works its way through our economic system, attention will be shifted from the collapsed deals to the design of future transactions. The vague language of past agreements has fueled disputes and threatened costly and uncertain litigation. Should future parties, in corporate acquisition deals and other commercial contracts, inject greater precision in their agreements? There are many proponents of this advice. However, we lack a theoretical framework for setting out the costs and benefits of vague and precise provisions. In this paper, we provide such a framework in order to improve awareness of the strategic use of vagueness in contracting.

The conventional rules-standards analysis suggests that vague terms are justified when the expected larger litigation costs in enforcing standards are outweighed by the lower costs of drafting. In acquisition agreements, this would suggest that vague MAC clauses yield benefits only by reducing front-end drafting costs. Yet, some proxies for material adverse change, such as quantitative thresholds in stock price, revenues or accounting earnings, are easy to draft and can be verified at low cost. They are usually noisy proxies, however, and therefore are not perfect.

We demonstrate that litigation costs, when properly harnessed, can in fact improve contracting by operating as a screen on the seller's decision to sue. We review three possible goals of MAC clauses: (a) to provide efficient incentives for investment and precautions against future contingencies by the seller between the time of the agreement and closing; (b) to allow the seller to better signal its private information to the acquirer at the time of contracting; and (c) to enable the seller to better signal private information at the time of closing, in order to promote ex post efficiency in terminating or executing the acquisition. We show that, in achieving these goals, vague provisions may work better than precise and even less noisy proxies.

Number of Pages in PDF File: 77

Keywords: contract design, mergers and acquisitions, options, litigation

JEL Classification: K12, K22, K41

Accepted Paper Series


Download This Paper

Date posted: April 4, 2009 ; Last revised: March 31, 2010

Suggested Citation

Choi, Albert H. and Triantis, George G., Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions (April 3, 2009). Yale Law Journal, Vol. 119, 2010; Virginia Law and Economics Research Paper No. 2009-16. Available at SSRN: http://ssrn.com/abstract=1372856

Contact Information

Albert H. Choi
University of Virginia School of Law ( email )
580 Massie Road
Charlottesville, VA 22903
United States

George G. Triantis (Contact Author)
Stanford Law School ( email )
559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
Feedback to SSRN


Paper statistics
Abstract Views: 3,147
Downloads: 1,047
Download Rank: 10,383
Citations:  1
Footnotes:  150

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.453 seconds