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General Counsel in the 21st Century
Challenges and Opportunities
By Christoph H. Vaagt, Wolf-Peter Gross
Globe Law and Business LtdCopyright © 2015 Globe Law and Business Limited
All rights reserved.
Integrating law and strategy: the value of legal astuteness
Constance E Bagley Yale Law School
According to a 2012 KPMG survey of 320 general counsel: "The role of general counsel is moving from one of 'fire-fighting' and reacting to events to being more strategic and proactively anticipating risks at an earlier stage." Because failure to comply with applicable laws can subject a firm to crushing government fines, the payment of billions in damages, termination of entire lines of business and imprisonment of its executives, any discussion of law and strategy must begin with compliance with law.
Yet staying out of trouble is only part of the picture. Lawyers can do more than help firms to anticipate and manage risk. They can create value by serving as 'transaction cost engineers' and 'enterprise architects'. Business lawyers: craft complex contractual relationships; structure joint ventures, licensing arrangements and other strategic alliances; organise and reorganise firms; practise preventive law; protect intellectual property; and handle regulatory matters.
But too often, managers view lawyers as a necessary evil, not a strategic partner. They treat law purely as a constraint, something to comply with and react to. In contrast, legally astute managers work with strategically astute counsel to solve complex problems and to marshal, protect and leverage resources. They possess a valuable dynamic managerial capability that may be a source of sustained competitive advantage under the resource-based view of the firm.
The resource-based view posits that "a firm develops competitive advantage by not only acquiring, but also developing, combining and effectively deploying its physical, human, and organisational resources in ways that add unique value and are difficult for competitors to imitate." Like failure to implement the correct corporate governance practices, failure to implement appropriate legal measures can prevent firms from fully realising the benefits of the other resources they control.
While recognising that "competitive advantage can flow at a point in time from the ownership of scarce but relevant and difficult-to-imitate assets, especially knowhow", Teece made it clear that "in fast-moving business environments open to global competition, and characterized by dispersion in the geographical and organizational sources of innovation and manufacturing, sustainable advantage ... requires unique and difficult-to-replicate dynamic capabilities." Teece divides dynamic capabilities "into the capacity (1) to sense and shape opportunities and threats, (2) to seize opportunities, and (3) to maintain competitiveness through enhancing, combining, protecting, and, when necessary, reconfiguring the business enterprise's intangible and tangible assets." There are legal components of each.
For example, because "the locus of world-class research/productive capability might lie external to the enterprise", firms may need to outsource at least aspects of their research and development to compete effectively. Legally astute top management teams can use a variety of legal structures to engage in research and development activities with others, such as university and company researchers, licensors and joint venture partners. Similarly, social media offer powerful means for discerning, anticipating and exploring customer needs, but the collection and use of personal data require adherence to the applicable laws and regulations governing privacy protection, which are particularly strict in the European Union.
Section 2 below sets forth the five elements of the dynamic capability of legal astuteness. Section 3 explains how legally astute top management teams and their strategically astute lawyers create realisable value while managing the attendant risks by:
using formal contracts as complements to relational governance;
protecting, redeploying and enhancing the value of knowledge assets and other firm resources;
using legal tools to create valuable options and to combat risk/loss aversion and overconfidence bias;
practising "strategic compliance management" and thereby converting regulatory constraints into opportunities; and
helping shape the 'rules of the game' governing business.
Section 4 explains that there are degrees of legal astuteness; Section 5 concludes with the systems approach to law and strategy, a descriptive integrating framework for understanding law and strategy.
2. Elements of legal astuteness
Legal astuteness requires:
a set of value-laden attitudes about the importance of law and ethical behaviour to firm success;
a proactive approach to management, regulation and risk;
the ability to exercise informed judgement when managing the legal and business aspects of business;
context-specific knowledge of the law and the appropriate use of legal tools; and
strategically astute lawyers.
2.1 Value-laden attitudes
Legally astute top management teams understand that "business decisions consist of continuous, interrelated economic and moral components". When dealing with conflict, business leaders and their counsel "should keep trying to reframe issues and refine tactics until they are satisfied that the firm's legitimate business objective of 'winning' in the marketplace is being advanced in an effective, legal, and above board manner." In short, they acknowledge that the moral aspects of choice are the final component of strategy.
The general counsel "is sometimes viewed as the 'ethics police person,' who catches inappropriate activities and institutes corrective actions to bring the rule-breaker into compliance with corporate governance standards. The GC is [usually] also a key member of the committees that examine the adequacy of internal controls and compliance with regulatory rules." Or, as Bond Pearce, managing partner Victor Tettmar, put it, general counsel should be the "guardian of moral capital".
Bagley and Bagley and Roellig assert that every manager has a responsibility to ensure ethical behaviour and compliance with law. 'Creative compliance' – that is, "complying with the letter of the law but defeating its spirit and purpose" and taking advantage of unintended legal loopholes – can lead to ethical and unlawful behaviour down the road.
Especially when discussing values, "management communicates as much by what it doesn't do or say as by what it says and does. In fact, behavioral forms of communication are apt to have more credibility than spoken or written forms." As Ben Heineman, former general counsel of General Electric, explained: "The stirring call for performance with integrity at the large company meeting can be eroded by the cynical comment an executive makes at a smaller meeting, by the winks and nods that implicitly sanction improprieties, by personal actions (dishonesty, lack of candor) that contradict company values."
The ethical business leader's decision tree (see Figure 1) is an example of a tool that legally astute managers can use to assess not only the legality but also the ethics of their proposed actions. Managers are encouraged to ask first whether the action complies with the letter and spirit of the law. If it does, then the next inquiry is whether it would enhance shareholder value. Even if it would not, legally astute managers will go on to ask whether it would be unethical to refrain from acting. This reflects not only the importance of meeting the manager's and the firm's ethical standards, but also the need to meet societal expectations, which directly affect a firm's licence to operate, the application and interpretation of existing laws and regulations, and the adoption of new laws and regulations. If the management team elects to take an action that is not legally mandated and does not enhance shareholder value, then it should disclose the reasons behind its decision to shareholders so they can take them into account when casting their votes for the board of directors at the next election. This transparency prevents management from using its professed concern for other constituencies or broad societal welfare to mask poor performance.
2.2 Proactive approach
Legally astute top management teams recognise that "[b]usiness corporations do not have legal problems. They have business problems where legal considerations may be more or less important, depending on the specific circumstances." Taking a proactive approach fosters threat and opportunity identification, learning and experimentation, key processes in dynamic environments. For example, a proactive strategy for reducing pollution and addressing other environmental matters that "anticipate[s] future regulations and social trends and design[s] or alter[s] operations, processes, and products to prevent (rather than merely ameliorate) negative environmental impacts" is a dynamic capability that can offer competitive advantage. According to Nehrt, firms' ability to reduce pollution became a source of competitive advantage only after firms replaced the mindset of reducing pollution to meet government endof-pipe restrictions with a search for ways to use environmentally friendly policies to create value. General Electric's ecomagination campaign, designed to promote the development and sale of energy-efficient products and to reduce its own emissions, reduced expenses by more than $100 million and increased the revenues generated by its environmentally friendly products, such as hybrid locomotives and more efficient jet engines.
Proactive strategies for dealing with the interface between a firm's business and the natural environment that went beyond environmental regulatory compliance were associated with improved financial performance. The continuum of approaches to managing the interface between business and the natural environment that Aragon-Correa and Sharma describe – which ranges from a reactive posture that responds "to changes in environmental regulations and stakeholder pressures via defensive lobbying and investments in end-of-pipe pollution control measures" to proactive postures – can be extended to the interface between business and other aspects of the legal environment.
Managers who view the law purely as a constraint, something to react to rather than to use proactively, will miss opportunities to use the law and legal tools to sense opportunities and threats, to seize opportunities, and to protect, marshal, leverage and redeploy tangible and intangible assets. As Siedel explained: "law plays an important role in both reducing costs and creating value for your customers – by enabling you to offer either lower prices or products that provide unique benefits." He provided examples from lawsuits dealing with product liability, workers' compensation, wrongful discharge, sexual harassment and environmental regulation to support this claim.
Managers who fail to be proactive will also lose the benefits provided by strategically astute lawyers, who can help to drive business success. As Bagley and Roellig explain, "the later a lawyer is brought into the planning of a transaction, the more likely it is that the lawyer will have to say 'no.' Anticipating this, business managers may provide counsel with a skewed set of facts in hopes of improving the likelihood of receiving the go-ahead." To avoid this dynamic and promote not only compliant corporate behaviour but also value creation and capture, general counsel should act as strategic partners and encourage managers to take an active role in legal matters from the outset – that is, to be legally astute.
2.3 Exercise of informed judgement
Legal astuteness requires the ability to exercise informed judgement. Law is not an exact science – legal rules are not applied formulaically. Seemingly minor changes in facts can result in dramatically different legal outcomes. Often, there is no clear precedent to serve as a guide. Dealing effectively with the uncertainties inherent in many decisions having legal aspects require the exercise of informed judgement. Legally astute managers – even those with formal legal training – do not purport to advise themselves on legal matters of importance. They appreciate the importance of selecting a true counsellor at law who combines knowledge of the black-letter law with judgement and wisdom. As (former Yale Law School Dean) Kronman explained: "wisdom is more than technical skill; it is the capacity to offer deliberative advice – that is, to go beyond merely supplying whatever means are needed to achieve the client's goals and to deliberate with the client about the wisdom of the client's ends." Certain courses of action may be legal but not wise.
2.4 Context-specific knowledge of the law and the application of legal tools
The non-lawyers on the top management team need context-specific knowledge of the law and the application of legal tools – that is, 'legal literacy' – so they can communicate in a meaningful way with counsel. Just as "[a] person trained as a scientist may have a difficult time understanding the point of view of a lawyer", top management teams lacking legal expertise cannot be expected to understand the legal subtleties underlying complex relationships and transactions in today's global economy. Managers and lawyers speak distinct professional dialects, further enhancing the potential for misunderstanding. To work together effectively, the lawyer and business leader must be able to understand what the other is concerned about; they must share a common vocabulary to "typify and stabilize experiences and integrate those experiences into a meaningful whole."
For example, in what Warren Buffett of Berkshire Hathaway called "the most successful managerial performance in bankruptcy I've ever seen", USG Corporation, manufacturer of Sheetrock(r) wall board and other building materials, successfully shed its asbestos liability pursuant to an orchestrated strategy that combined:
filing for bankruptcy under Chapter 11 so it could obtain a 'channelling injunction' whereby the plaintiffs suing for asbestos-related disease would be required to seek redress solely from a dedicated trust funded by USG and approved by 75% of the claimants;
lobbying for federal legislation to create a multi-firm fund for the payment of asbestos personal injury claims in accordance with accepted medical standards for determining the existence and severity of asbestos-related disease;
litigating dubious claims;
a human resource strategy that valued both factory workers and up-and-coming managers;
transparency with both investors and employees;
a reputation for reliability and honest dealing with suppliers, customers and employees; and
the ability to shift resources from primarily manufacturing Sheetrock(r) and other building materials to distributing other firms' products as well.
USG emerged from bankruptcy five years after filing with a channelling injunction in effect pursuant to a reorganisation plan that was approved by 98% of the asbestos claimants and a shareholder committee led by Warren Buffett, whose holding company Berkshire Hathaway owned about 15% of USG's stock and backstopped a $1 billion rights offering, with all debts paid in full with default interest, shareholder equity intact, and more than a 50% increase in revenues. Although USG chief executive Bill Foote conducted this 'orchestration' and played a critical role lobbying for changes in the law, USG's success would not have been possible but for Foote's own personal knowledge of law and legal tools, and his close relationship with general counsel Stan Ferguson and other in-house lawyers along with the outside lawyers who helped to litigate the asbestos claims and advised on the bankruptcy proceedings. It also would not have been possible absent USG's ability to restructure its business to include counter-cyclical lines, such as distribution, and to grow the company through acquisitions.
2.5 Strategically astute counsel
General counsel (also known as chief legal officers) perform a multiplicity of roles, including manager of the legal department, legal adviser and educator, negotiator, crisis manager and strategic planner. They are "the 'Swiss army knife' of the legal profession." Legally astute managers acknowledge the "right and responsibility [of inside counsel] to insist upon early legal involvement in major transactions". They call on their lawyers to play an active role in formulating the corporation's strategy as a whole rather than just bringing them in to serve as technical consultants after a legal problem has arisen or the management team has already decided what to do.
The lawyers have to earn the respect and trust of the non-lawyers on the top management team to get a seat at the table from the outset. Trust is a firm-specific relationship, which cannot be readily recreated when a lawyer or manager leaves to join another firm.
Excerpted from General Counsel in the 21st Century by Christoph H. Vaagt, Wolf-Peter Gross. Copyright © 2015 Globe Law and Business Limited. Excerpted by permission of Globe Law and Business Ltd.
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