Warren Buffett’s Business Contracts Should Be A Model For The World

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Rupert Hargreaves
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The writing and interpretation of business and legal contracts has always been a specialist business. Over time, as deals have become more complex and the legal system has grown (along with the number of new laws and regulations) the construction of both business and legal agreements, in and outside the private sector, has become somewhat of an art. The interpretation of these legal contracts has also become a specialist subject to the degree where some legal agreements may have different meanings in different states.

According to professor Lawrence Cunningham, this stubborn “winner-take-all” approach it’s now starting to lose favor with some lawmakers in favor of a flexible and practical “best-tool-for-the-job” approach.

This approach, which he has labeled as “contract interpretation 2.0” drawers on the contracting philosophy and practices of billionaire Warren Buffett, which Cunningham explores in a new essay titled “Contract Interpretation 2.0: Not Winner-Take-All But Best-Tool-For-The-Job.

Warren Buffett has built his reputation on his ability to do deals. These deals have never been known for their complexity; in fact, it is quite the opposite. Buffett is famous for doing deals on a handshake, and judging management there than on their ability to be able to continue to produce returns. Over the years, as Berkshire Hathaway has grown to become one of the world’s largest companies, his approach has changed with regards to contracts, but not by much.

The desire to keep contracts simple and costs low Cunningham claims is based on Buffett’s deep-rooted desire to achieve the best returns for himself and his partners at all times. Indeed, within the paper, Cunningham points out that even today, Buffett still regards Berkshire shareholders as his partners. As the head of a partnership, Buffett’s fiduciary duties are more demanding than for corporate directors. He does not have to adhere to the strict standards, but he chooses to anyway. Cunningham claims that this desire to treat shareholders as partners, as well as Buffett well-known desire to buy businesses with no intention to sell it, are two “informal promises repeated for decades” that help with construction of contracts because counterparties are well aware of his desires and intentions. There’s no requirement to include clauses stipulating a holding period or treatment of stakeholders because Buffett has repeatedly made it clear how he works in business.

The second factor that has helped smooth the construction of contracts at Berkshire is Buffett’s ability to agree on deals in principle early on with management before moving onto anything more official. An example given in the paper is that of one of Berkshire’s most important deal as it marked the beginning of the company as we know it today, the 1967 purchase of National Indemnity Company:

“Jack Ringwalt, a friend of mine who was the controlling shareholder of the two companies, came to my office saying he would like to sell. Fifteen minutes later, we had a deal. Neither of Jack’s companies had ever had an audit by a public accounting firm, and I didn’t ask for one. My reasoning: (1) Jack was honest and (2) He was also a bit quirky and likely to walk away if the deal became at all complicated. [The purchase agreement we used to finalize the transaction was 11 /2 pages long.] That contract was homemade: Neither side used a lawyer. Per page, this has to be Berkshire’s best deal: National Indemnity today has GAAP (generally accepted accounting principles) net worth of $111  billion, which exceeds that of any other insurer in the world.” — BERKSHIRE HATHAWAY INC., 2014 ANNUAL REPORT 8 (2015) (Chairman’s Letter)

Another deal done with the same handshake style approach was the purchase of the Nebraska Furniture Mart:

“I went to see Mrs. B (Rose Blumkin), carrying a 11/4-page purchase proposal for NFM that I had drafted. . . . Mrs. B accepted my offer without changing a word, and we completed the deal without the involvement of investment bankers or lawyers (an experience that can only be described as heavenly).” — BERKSHIRE HATHAWAY INC., 2013 ANNUAL REPORT 15 (2014) 

Even though Buffett tries to complete deals with as little formal paperwork as possible, on occasions deals do require legal promises. Here Berkshire relies heavily on the “spirit and the letter” observing informal promises solemnly while honoring formal promises “quite conditionally.” But there are occasions where Berkshire could be interpreted to be in the wrong due to the complexity of the law and ambiguity of certain statements. This “shows that it would be desirable to develop a body of literature that guides courts in choosing the right tool for the job rather than continuing the binary debate” according to Cunningham’s paper.

Buffett has created the perfect environment at Berkshire to do deals. Not only does he have a trusted law team headed by Charlie Munger, but over the past few decades, he’s been cultivating his image in a way that helps smooth the construction of contracts.  The method’s Buffett uses to construct contracts should, according to Cunningham’s paper, provide a framework for the legal system to “emerge from a binary debate to a hybrid where participants recognize that the right tool for the job varies.” The contracts of Berkshire Hathaway suggest hybridization has “greater promise than stubborn rehashing does.”

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