How to do “Anti-Law” (What is “Anti-Law” – Pt 2) Reply

THE BIG IDEA

Designing legal clauses should be an extension of the architectural process.  The contract then should be about 75-85% by design directly from the business and technical architectures and the taxonomy (terms).  The rest will be terms of art (contract construction, jurisdiction etc).

WE ALREADY DO IT

The first thing people say to me when I set out this proposition is that it’s obvious and sensible.  So, why isn’t it done already?  Well, to a certain extent it is, we just don’t know it.  Secondly, it’s not intuitive – it’s not the logical next-step when we’re doing the work.  Firstly, we do already do it:  most commercial and technical managers already understand a great deal of the law surrounding their areas and simply design around it. Secondly, commercial architecture – cost models, program plans etc which are just the attributes of the other architectures – have no spatio-temporal extent.  We can’t see, feel or touch them like we can the stuff we’re engineering and therefore our understanding is governed by how we construct these concepts and thoughts in our mind (Wittgenstein).

THE COUNTERINTUITIVE BIT

The counterintuitive bit is that many commercial entities are actually separate things  – they are relationships to an entity.  In ontological terms they are ‘tuples’ and instantiated on their own.  In the same way that a packet of cornflakes has a cost and then the manufacturer puts a price on it.

The price is a different thing but related to the cost. We know that the price, in turn is related to their profit margin which in turn is related to their overheads which in turn are made of R&D costs, admin, advertising etc.  All these elements are part of the business architecture which influences the commercial (financial and legal) architecture of the given project.

WHAT RELATIONSHIPS

Risk is the key relationship we are modelling.  It is best to see risk as a relationship rather than a property.  Widget A does not have risk in and of itself.  Widget A does have risk when used in a certain machine, in a certain contract.  This is important to note because in later whitepapers I will talk about the need to separate the logical and physical commercial architectures in order to make trade-offs and impact assessments.

ARCHITECTURAL RISKS

Risk links to architecture through a series of relationships.  Ultimately, if we look at components in a database then the relationships I would draw would be:

REQUIREMENT > ELEMENT > CONTEXT > RISK > MITIGATION > MITIGATION INSTANTIATION > CONTRACT CLAUSE.

In the above the ‘context’ is the domain architectural instantiation (the physical architecture) we are modelling, for instance, Architecture A or 1 etc.  This allows us to compare risk profiles across different possibilities and then make trade-offs.  The difference between the ‘mitigation’ and the ‘mitigation instantiation’ is merely logical v physical.  Logically we might wish to insure against a risk but when it comes down to it physically we are insuring part, funding part with a bond issue and hedging against the rest. The point is to identify clearly in the model what is mitigated and what is not.  In a large and complex model of thousands of elements we will want to make sure that all mitigations are accounted for and their are no overlaps.  If we’ve overlapped mitigations (insurance, loans etc) on a number of parts then the cost could be astronomic.  The calculations will be clearer in later whitepapers when I explain how to aggregate derived risk.

PHYSICAL MITIGATIONS

The physical mitigations are the most important things to agree on.  These are the processes and the structures that the business must agree on.  This will be a collaborative effort of legal, financial, technical and programmatic.  They must be realistic, sensible and accounted for in the program plan.  Once clearly set out then a precise and specific contract clause (not a mopping-up clause) can be tightly crafted around each and every one.  These clauses must have triggers built into the program plan and each trigger must have adequate information derivation for decision making (ie, you need to know when the clause might need to be used).

The trick in all of this is not in deciding what to do but in identifying the risks in the first place but that is for examination another time.

HOW TO MITIGATE

Repackaging risk to mitigate effectively will be the topic of another blog.

The Architectural Enterprise: developing an EA program in an organisation Reply

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Enterprise architecture is what happens not what an organisation does.  The teams, roles, structures and functions already exist within most organisations. The benefits of an enterprise architecture are best driven from a central, cross-functional governing body which has the power to (a) analyse the business and (b) drive alignment of the technical architecture.

EA is not a separate team or function.  EA is best achieved from a high-level by linking the functions of teams and business units. Most businesses already have enough EA structures already  in place.  The usual failing is focus not facilities.

Using an active governance, risk & compliance framework enterprises can ensure alignment of business capability and technical architecture.  To achieve this businesses should focus on the following 3 steps:

  1.   Focus on Business Capability not technical architecture.
  •   Use financial modelling.
  •   Use Value Chain modelling for alignment.
  •   Use parametric modelling to ensure that capability does not decrease with costs.
  1.   Become a source of value for the business.  Offer capability development into the Strategic Business Units.
  •   It is the only way to get full visibility of their cost structures.
  •   Build better stakeholder buy-in for complex projects.
  1.   Enterprise Architecture best sits within the GRC function.  An Architectural Council (Tier 2 executives) which helps provide the focus for architectural development.
  •   Reinvigorate the Business Lifecycle Governance Process with dynamic assurance measures.
  •   Remove much of the onerous, burdensome program review and develop a more analytical assurance based model.

The Construction of Contracts: Problems with Plain English for the Interpretation of Legalese 1

Lawyers have long been derided for their use of verbose and complex language.  Businesses often criticise legal teams for turning simple commercial agreements into indecipherable esoteric jargon.

The state of legal drafting is likely to be responsible for a large portion of the commercial litigation occurring these days.

TECHNICALITIES

When I was at law school someone asked why judgements were written in such complicated language.  The lecturer gave the rather unsatisfactory answer of “well, they just are, so I suggested you get used to writing like that as well.”  So begins the institutionalisation of the legal mind.  Whilst lawyers argue that complex topics beget complex documents it need not always be the case.  It is simply not sufficient to argue that circumlocutory language is essential to navigate the labyrinthine technicalities of the law.

MEANING v INTERPRETATION 

The problems is not the generation of meaning it is surviving interpretation.  For instance, it is one thing to explain a business model so that your nine year old daughter understands it.  It is another thing entirely for the same language to stand up to intense scrutiny from another party who stands to lose money on that interpretation.

The phrase lawyers use is “covering the field”.  Lawyers reduce the penetration of an attack by reducing all the avenues of construction so that there is only one possible interpretation.  What is left is usually a wordy cocktail which is so complex that it defies the very interpretation intended.

THE PROBLEM WITH PLAIN ENGLISH

The problem with plain English is that it dumbs-down complex concepts.  Jargon, on the other hand, usually arises in two situations:  (a) where the author seeks to look cleverer than they really are, and (b) where the author is trying to convey complex concepts precisely to an audience of the same background understanding.

The fact is that English is an imprecise language.  It is no wonder that French is the international language of diplomacy.  For instance, in English we have no gender for our nouns.  There is no way of telling which preceding noun the ‘he’ or ‘she’ of a sentence relates to.

UNDERSTANDING THROUGH CONCEPTUALISATION

Understanding, therefore, is created through a common conceptualisation not the design of the language.  Two builders, for example, will understand an agreement to build a house based on the architectural schematics.  Two bankers will, likewise, understand the securitisation of debt and sale as a derivative.  Both of these contracts will be entirely opaque to most of us and certainly to the nine year old daughter.

The trick, therefore, is in the creation of a common conceptualisation, one that is understandable and interpretable to the rest of us.  “The rest of us” should include the judge and expert witnesses should the matter ever be disputed.

ARCHITECTURE

English, therefore, is not the problem.  Architecture is the problem.  Agreements fail through the inability to create a common operating model.  Much can be brought over from the building and construction industry wherein the architecture, engineering and schedule form key artefacts of the business agreement and reduce ambiguity and uncertainty.  Likewise, where parties create an easily interpretable model (physical or conceptual) then the likelihood of  ambiguity, misinterpretation or, perish the thought, obligation avoidance, is greatly reduced.  Defence departments are moving this way through the use of Defence Architecture Frameworks (such as MoDAF, DoDAF and NAF) although none are optimised for the use in legal documents just yet. However, it will be a long time and only with huge a huge push from the business community that the state of legal drafting will change for the better.

How Integrated Contract Lifecycle Management Can Reduce Legal Fees 1

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In a recent study by the American Bar 58% of procurement departments noted that they had been involved in purchasing legal services for three or more years.  More than half the respondents were Fortune 1000 companies and about a third were Fortune 100.

Despite this trend most legal work is neither panel-based nor subject to competitive reverse-auction processes.  In fact, back in 2007 McKinsey Quarterly ran an article titled “Inventing the 21st Century Purchasing Organization.”  They noted that businesses had woken up to the cost benefits of strategic sourcing and intelligent supply and management.

It is my prediction that with the massive oversupply of law students and as more lawyers move out of the profession into traditionally non-aligned areas our age will see a large rise in the need for law firms to become highly competitive.

The American Bar reported an interview with the Chief Procurement Officer of a large company.  He stated that “if you know your business, you should know how long something takes and how much something should cost”.  He had worked in the nuclear power industry and thought that building nuclear power plants was a lot more complex than litigation.  Understandable, although I should add that in most industries (Defence excluded) there is no one on the other side conspiring to destroy your plans.  Needless to say, he has a point.  Most law firms track costs but they don’t track work.  They track bills but they don’t track customer value.  Legal work suffers from a dire lack of transparency largely because it doesn’t need to.  In the legal profession it does no one any good to try and commoditise their work.  However, that’s exactly what needs to happen.  In many areas the rise of the paralegal (e.g. conveyancing) has been aimed at increasing profit margin internally rather than increasing customer value externally.

In order to increase customer value to corporate clients law firms must integrate their services with the company’s business lifecyle.  When this occurs the results will likely decrease total legal spending per project but they will likely increase the total number of projects using external legal assistance.  Why?  for the same reason iTunes didn’t decrease the per capita spend of teenagers on music.  Integrate with their life style.  Give them more opportunities to spend.  With a clear idea of the value external counsel can offer on a specific deal or project and the ability to keep the legal spend down it is likely that managers will seek to use that new found power to cover themselves rather than have their own accounts and reputations wear the risk.  The effect on total law firm revenue should be negligible but the effect on law firm structure should be striking.  As the commercial legal sector strives to accommodate the need for increased throughput there will likely be a greater emphasis on workflow and process.

The graph above outlines (in red) the traditional legal spend.  Very high costs being injected at pre-determined points of the business lifecycle.  This does not take into consideration all the costs which are incurred from failed contracts and poor contract management.  The blue graph outlines the standard curve from contract management expenses.  Current contract management professionals are involved earlier in the business lifecycle.  Where problems arise of specialist legal expertise is involved then external counsel are involved.

Gartner note that in 75% of the contracts they review they find hard dollar savings.  As markets develop and try to develop new revenue models through licensing options and new pricing structures it is vital that the operational parts of the business remain up to speed.

Law firms are very important and they are not going away.  The depth of knowledge they provide and the expertise in navigating transactions, deals and disputes cannot be delivered through new software.  The trick, however, is to  maximise the value for money from law firms.  The best way to achieve value for money is to ensure that detailed legal advice or drafting is injected at the precise point of value from the most valuable person and this is where intelligent procurement will have the most impact.

Most importantly, legal advice and transactional support is not operational. There are very few lawyers in very few sectors who have operational awareness let alone operational experience.  This is where professional contract managers can have the most impact.  By detecting risk in the subtleties and complexities of operational and technical minutiae contracts professionals can have a huge impact.  The company is likely to spend less on legals as well as making it a far wiser and effective spend than now.

What does this say about contract management today?  Contract management is by and large an ineffectual and redundant function.  Sandwiched between project management, operations and legal – and adding little value to any of them – one has to ask what the point is?

What does effective, integrated contract management look like?  It would mean that once operational problems were detected and identified then analysed the contract managers would be able to determine the precise level of legal exposure.  This would require the contract management function to be able to analyse financial, operational and technical issues within contracts and assess them for validity, severity and impact (including probability).  The contract managers are then empowered to assist the business to deal with these problems.  This is not the contracts and commercial departments of today.

The contract management function described above requires a variety of monitoring systems:  From the top down, the business needs to analyse cost structures and EBIT for risks before variances arise.   From the bottom up, the CRM systems need to percolate a wide variety of issues which line managers can analyse for veracity, velocity and trend.

Identifying issues as potential contract problems is NOT the job of most line managers.  The contract professional has that job with the assistance of the program manager/account manager but acting together in an integrated business lifecycle a modern contract management function has the ability to reduce risks and legal spend significantly.

Risk Cascades: Managing Financial Exposure from 3rd Party Contract Risk Reply

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In an October 2009 article in McKinsey Quarterly the authors Eric Lamarre and Martin Pergler outline how indirect risk is the key to reducing net residual risk.

Net residual risk is the risk a business is left with after they have dealt with all the obvious risks.  For instance, obvious product liability, insurances for warranties and even hedges for currency or commodity price volatility. Net residual risk of over 30% is often standard for ICT contracts (scope creep, unforeseen faults etc).

Significantly, net residual risk is hidden risk.  More importantly, hidden risks can sink deals and kill companies because not only is the risk uninsured (financially or operationally) its unforeseen nature means that surprise brings with it increased cost and severity (i.e, by the time it percolates to the top it has already boiled over into a significant issue).

The fact of the matter is that indirect risk creates potentially huge financial exposure.  It does so because indirect risk cascades.  Indirect risk is exponential in its nature because it cascades through an organisation or throughout a contractual network.  As each party adds its own risk premiums to a cost which has a hidden risk, it aggregates in a non-linear way.  The resulting overall exposure can be huge.

Take, for instance XYZ Parts Inc. have a manufacturing contract for making Widget X as part of a navy submarineThe widget is made to the wrong dimensions. XYZ Parts is liable but has no way of paying and their insurance is minuscule and will not cover the liability.  As this risk has cascaded throughout the contract network it has aggregated exponentially to create huge financial exposure to the Prime.  The diagram below shows how this happens.

In a recent CFO survey (CFO magazine, “Working Well Together:  managing third party risk in a more integrated world) CFO magazine came up with some surprising results, namely:

  •   Fewer than 50% of CFOs thought their company had well defined processes for dealing with third party risk, however
  • 38% noted that third party risk identification and visibility is one of their top 3 priorities, and
  •   roughly 75% responded that a third party had harmed their business in some way.

Pegler and Lamarre note that the likely causes are due to (a) lack of senior executive involvement in enterprise risk management, and (b) poor and disconnected risk management practices.

In a recent brochure I outlined one way to manage third party risk.  It is very difficult to develop operational procedures to deal with contingent risk.  Corporate feudalism dictates that identifying risk and stepping in to another division (or company)  to deal with it is complicated.  Firstly, in the opaque and murky world of rivalries between companies or divisions in a contractual network the risks need to be identified architecturally.  The architecture (engineering or ICT) is the only aspect that is transparent.  Only by using central models can all parties identify risks which impact their business.  Secondly, contingent risks can be ‘sold’ to other companies in the network (through, for instance, put or call options in the contract).  In this way, an internal hedge market is created for dealing with third party risk).  This is a far better way of dealing with significant indirect risks as ultimately it engages the powerful finance function and creates huge inducements to contractual performance (such as wholesale loss of intellectual property).

Regardless of how risk is managed most senior executives agree that in our modern, interconnected world it is no longer sufficient to leave third party risk to chance or to blanket boilerplate of standard contract clauses.  If companies are to reduce financial exposure from third parties risk must be hunted down and dealt with; specifically and in detail.