Plain English Project #5

Abilities, Rights...and Incentives

Welcome to the Plain English Project (aka “PEP”). I’m a business lawyer that grew up around family businesses. I know the pain of small business owners overwhelmed when a practical decision intersects with a legal question. I cut through that legal fog so that regular people can make clear-headed decisions.  

Abilities, Rights….and Incentives

This is the last of the “Abilities vs. Rights” topic. In PEP #2, PEP #3 and PEP #4, I discussed how contracts function in real life. I’ve spent a lot of time talking about the limitations of contracts. Times when you wish in vain that a contract could make someone behave differently. For small-dollar contracts in particular, the limitations are real.

By “small-dollar” I mean contracts involving an amount of money that is less than the cost to enforce the contract in court.¹ It’s time we put a name on these types of contracts: Hard Lemons. There might be some juice in them, but it’s mathematically certain to not be worth wrestling it out.

So where does that leave the users of these small-dollar contracts? Are Hard Lemons even worth the cost of writing them? I believe so and I’ll make that argument in more detail in upcoming articles. For now let’s assume they are. In that case, if most of your contracts are Hard Lemons, how can you confidently do business at all?

The answer is not what most attorneys will tell you: relationships and incentives.

The Small Business Ecosystem

In Hard Lemon contracts, the incentives are more personal. Deals are negotiated and carried out between individuals. The party on the contract might be “Laura’s Furniture, LLC,” but the person behind the company is Laura. A whole community of customers knows her face. She’s a good person to buy furniture from because her motivation comes from a personal need to keep customers happy, regardless of what her contract terms might say. She in turn must find suppliers with the same personal investment in keeping her happy.

I’ve explained before how contracts create legal rights, not present abilities. From another angle, you could say contracts create incentives. Some incentives are more remote and theoretical than others. For example, following the contract can lead to immediate payment (instant reward), but it can also prevent a hypothetical future lawsuit from happening (distant possibility, though peaceful sleep each night goes a long way).

Having a plain English contract spells out in clear terms what the positive and negative incentives are for each side. “Rights,” “obligations,” “damages,” “remedies,” are all other ways of saying “incentives.” The more I see and think about the legal world, the more I believe that all contracts boil down to incentives.  

Consider an example from the opposite of a small business. When you buy a share of Apple stock, you have no direct relationship with anyone at Apple. They don’t know you, you don’t know them, and there is little reason for them to give you any thought at all. However, you are connected to them through a series of contracts between Apple and all shareholders. If Apple breaks a contract with you, it has also offended the people holding the other 16 billion common shares. What makes their shareholder contracts function is the large incentive to avoid kicking that beehive.

In the same way, simple incentives drive every small business relationship. For each person you work with, what reasons do they have to do their job well?

It is worth the exhausting effort to seek out partners, vendors, employees and customers who all have incentives to work towards the same outcomes as you. An entire industry of consultants, recruiters and middlemen promises to do this work for you. Successful business owners will tell you it is work you can only do for yourself. 

The value of a written contract between you and a quality partner is that it makes those aligned incentives legible. Even if you can’t practically enforce the terms, the contract is a written signal to each other and the world of how you will behave.

Weak Wizards

You may think it is strange for a lawyer to be so negative about both lawsuits and contracts. Lawyers don’t usually speak in these terms because we need society to believe we are wizards that control human behavior. Yes, we can step into some situations and adjust people’s actions, but only to a point.

People should do everything they say in a contract, but they don’t. People should immediately change their actions when they are sued, but they don’t. Judges and juries should agree with your arguments without delay or qualification, but they don’t. Hell, a good chunk of the time we are telling our own clients to behave better, but they don’t.

The more you surround yourself with thoughtfully-incentivized people, the more you build a world where people do what they say, and the less you will need a lawyer to cast an improbable spell in the future.

Coming Up

The next set of articles will discuss the difference between negotiations and disputes. I’ll discuss how the right lawyers can help (and how the wrong lawyers can hurt) in each case. Please subscribe to get notified when I post new pieces.

Thanks for reading and have a great week!

1. You may wonder how this relates to “small claims” lawsuits. States do have courts designed to hear cases involving low dollar amounts. However, those amounts can be too low to apply to small business contracts. For example, in Texas the maximum amount you can sue for in small claims court is $10,000. Very importantly, that $10,000 includes any attorney fees you might win from the other side. An attorney’s work to prepare and present in a small court trial could easily exceed $10,000 by itself. Even if you win the maximum amount, your net gain can be at or below $0. You also will need to go and collect the money from the other person, which is guaranteed to cost more money with no guarantee of receiving a penny.