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The Hired Gun as Facilitator: Lawyers and the Suppression of Business Disputes in Silicon Valley

Published online by Cambridge University Press:  27 December 2018

Mark C. Suchman  and
Mia L. Cahill
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Abstract

This article draws on interview data from California's Silicon Valley to explore the role of local business attorneys in shaping the market for high-technology start-up financing. Far from exerting a disruptive or disputatious influence on business relations, Silicon Valley lawyers actively facilitate the functioning of the region's venture capital sector. In particular, attorneys intervene in the start-up process to absorb, suppress, and avert crucial uncertainties that might otherwise elevate transaction costs, imperil economic activity, and foster interorganizational discord. Local law firms moderate the hazards of new-company financing in at least three distinct ways: (1) by directly absorbing economic uncertainties in individual transactions; (2) by constructing, preserving, and reproducing normative and cognitive understandings within the community as a whole; and (3) by incorporating these local practices into the external legal regime.

Type
Symposium: Business Disputing
Information
Law & Social Inquiry , Volume 21 , Issue 3 , Summer 1996 , pp. 679 - 712
Copyright
Copyright © American Bar Foundation, 1996 

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References

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44 Here and below, we use the phrase “Silicon Valley law firms” in a relatively restrictive sense. Not all lawyers within the geographic boundaries of Silicon Valley are engaged in “Silicon Valley law.” Indeed, the region has its share of real estate lawyers, criminal lawyers, divorce lawyers, etc., and there is little reason to believe that these practitioners differ significantly from their counterparts in similarly affluent communities elsewhere. Our analysis, instead, centers on those corporate law firms that draw their clienteles disproportionately from the region's hallmark high-technology industries-semiconductors, computers, software, telecommunications, biotechnology, and the like. This is not a large universe; indeed, the vast majority of high-tech legal work is concentrated in the hands of fewer than ten firms. Moreover, since some of these high-tech firms specialize in patent or regulatory law, the degree of concentration becomes even greater when one focuses (as we do here) on legal representation in the venture capital financing process. Nonetheless, the few firms with large venture capital practices clearly set the tone for the local legal community, and their activities are of substantial theoretical importance for understanding the role of the legal profession in this particular setting.Google Scholar

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46 It is unclear whether venture capitalists attend to such displays of faith in assessing companies as potential investment opportunities.Google Scholar

47 France, Michael, “Craig's Excellent Venture,” 13 Cal. Law. 53, 56 (Aug. 1993). The article goes on to note (p. 122) that for Johnson's new firm:. [T]he client investments will average a little less than 1 percent of the company's value, generally about $10,000 to $25,000. Additionally, the firm expects developing companies that have not become profitable to give it the same stock options granted to outside directors for attending board meetings. While the firms's investments will not be large-to safeguard against a potential conflict of interest or an investor suit-the good ones should offer what multimillionaire Johnson refers to as “a nice little kick.”. This approach seems broadly congruent with the practices embraced by most of Silicon Valley's leading law firms throughout the 1980s.Google Scholar

48 See Suchman, “Silicon Valley” (cited in note 5).Google Scholar

49 Among the many documents exchanged during a venture capital financing is an “opinion of counsel letter,” provided to the investors by the law firm representing the start-up company (or occasionally by an outside firm hired specifically for this purpose). In theory, these opinion letters furnish investors with a formal legal opinion on the adequacy of the company's preparations for the financing-capitalization, corporate authority, validity and due issuance of stock, etc.-and on the accuracy of various material representations regarding, for example, patent protections, outstanding debt obligations, employment agreements, and the like. Although the opinion letter merely recites a list of factual assertions about the startup, it is signed by the law firm, and any misrepresentations would expose the law firm to liability for malpractice or even for fraud.Google Scholar

50 In this regard, opinion letters in venture financings differ from the fairness opinions studied by Bebchuk and Kahan in the context of corporate mergers. Lucian A. Bebchuk & Marcel Kahan, “Fairness Opinions: How Fair Are They and What Can Be Done about It?” 1989 Duke L. J. 27. Unlike venture financing opinions, merger opinions arguably provide arm's-length parties (outside directors and stockholders) with nonredundant information that might be difficult to obtain elsewhere.CrossRefGoogle Scholar

51 While the boundary between intentional falsehood and excessive optimism may be hazy, it seems clear that the Silicon Valley bar tends to interpret the ethics of opinion letters somewhat more leniently than the legal profession at large.Google Scholar

52 Kagan & Rosen, 37 Stan. L. Rev. 399 (cited in note 6), too, include “insurer” among the central roles of the corporate attorney. The insurance that they have in mind, however, is in many ways the diametric opposite of the insurance described above. The conventional “insurer” role involves the drafting of precisely the sort of elaborate contractual protections that Silicon Valley legal culture systematically denigrates. Interestingly, both hypercautious contingency contracting and direct exposure of law firm resources help clients to manage uncertainty; however, since the former approach merely highlights risks and allocates them among the parties, it is generally experienced as being far less “facilitative” than the latter.Google Scholar

53 Suchman, “Silicon Valley” (cited in note 5).Google Scholar

54 Although “shaping client behaviors and setting client expectations” would seem to go well beyond the traditional range of legal services, Silicon Valley is not the only context in which “lawyering” involves the transformation of clients' understandings of social reality. In studying divorce cases, for example, Sarat and Felstiner find that lawyers and clients often negotiate and struggle over the extent to which legal schemata will dominate their joint behaviors and interpretations. The authors note that “by limiting interpretive activity to their area of expertise, lawyers are able to explain the social world through the lenses of the legal process. They are able to structure conversation to fit their rational-purposive ideology and to limit the impact of their clients' egocentric views of social life.”Sarat, Austin & Felstiner, William, “Law and Social Relations: Vocabularies of Motive in Lawyer/Client Interaction,” 22 Law & Soc'y Rev. 737, 765 (1988). This process seems somewhat analogous to the normative and cognitive work of the Silicon Valley law firm. In both settings, lawyers shape the personal and economic expectations of their clients, in addition to performing more traditional “legal” tasks.Google Scholar

55 For a more detailed discussion of the role of Silicon Valley lawyers in shaping community structure, see Suchman, “Silicon Valley.” Suchman identifies two main clusters of law firm activities: “deal making,” in which law firms mediate flows of operational resources, and “counseling,” in which law firms mediate flows of constitutive information. The three activities described in the present analysis-gatekeeping, proselytizing, and sorting-are described by Suchman as “mixed effects,” conjoining elements of both deal making and counseling in single sets of behaviors. It is hardly surprising that such mixed effects should predominate in the context of venture capital financing, where relatively naive start-ups look to their attorneys for both advice and introductions.Google Scholar

56 Galanter, Marc, “Why the ‘Haves’ Come out Ahead: Speculations on the Limits of Legal Change,” 9 Law & Soc'y Rev. 95 (1974).Google Scholar

57 Bernstein, 21 J. Legal Stud. (cited in note 18).Google Scholar

58 It is worth noting that Silicon Valley law firms screen prospective clients primarily for social, not technological, characteristics. With a very few exceptions, Silicon Valley attorneys do not hold themselves out as engineers, futurists, or market researchers, and venture capitalists do not seem to expect this of them. However, lawyers are relatively well positioned to evaluate whether entrepreneurs are “serious,”“focused,”“cooperative,”“businesslike,” and so on, and these are the sorts of community norms that the region's law firms seem to be applying in deciding which clients to represent and which to turn away. It is also worth noting that the role of law firms in weeding out undesirable clients appears to have arisen relatively recently in Silicon Valley's history. To some extent, the less discriminating posture of law firms during the community's early years presumably reflected their narrow economic interests in attracting new clients; however, it seems likely that the absence of gatekeeping in the early community also reflected the absence of well-developed normative standards by which to evaluate potential community entrants.Google Scholar

59 Emile Durkheim, The Division of Labor in Society, trans. G. Simpson (New York: Free Press, 1969).Google Scholar

60 Of course, the social control implicit in gatekeeping has costs as well. Gatekeeping allows powerful actors within the community (law firms, in this case) to conserve community resources and to redirect them toward nonthreatening “preferred” uses-often against the wishes of certain disenfranchised groups. Consequently, one cannot assess the desirability of such efforts without also assessing the desirability of the activities that the community privileges and those that it excludes. This is an essentially prescriptive task that goes beyond the scope of this essay.Google Scholar

61 Abbott, 86 Am. J. Soc. 819 (cited in note 5).CrossRefGoogle Scholar

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63 A junior partner at this firm lists some of the factors that enter into such steering decisions: “What industry they're in, because some VCs will be more interested in certain industries than in others. Where they are located. Are they in a very early stage, where they need a venture capitalist to help provide infrastructure and the like, or are they further along? Are they a real top-notch prospect or one that's further down on the scale? How big are their capital requirements?”.Google Scholar

64 DiMaggio, Paul J. & Powell, Walter W., “The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields,” 48 Am. Soc. Rev. 147 (1983).Google Scholar

65 This quotation and the previous one suggest that standardized contractual provisions are most likely to be seen as consensual, natural, and morally proper in settings where individual lawyers “play both sides of the fence,” so that they hear their own prior demands echoed back to them from opposing counsel in subsequent transactions. This situation is quite common in Silicon Valley venture capital financings. As one prominent attorney observes, regarding his own firm: “Clearly, everyone has identified the fact that you really want to end up representing the start-up company, and that's really the highest calling. But that's not to say that representing investors isn't interesting and attractive. For a variety of reasons, we think it is, and we continue to do a lot of that work.” Such switch hitting is certainly not the norm in many areas of American legal practice, and in those fields where attomeys rarely switch sides, one might expect standard-form contracts to be more recurrently contested. Labor law perhaps provides the most obvious case in point.Google Scholar

66 Galanter, Marc, “Justice in Many Rooms: Courts, Private Ordering and Indigenous Law,” 19 J. Legal Pluralism & Unofficial L. 1 (1981); Merry, Sally Engel, “Legal Pluralism,” 22 Law & Soc'y Rev. 867 (1988).Google Scholar

67 Under the Uniform Commercial Code:. (3)… [A]ny usage of trade in the vocation or trade in which [the parties] are engaged or of which they are or should be aware give particular meaning to and supplement or qualify terms of an agreement. (4) The express terms of an agreement and an applicable… usage of trade shall be construed wherever reasonable as consistent with each other…. (5) An applicable usage of trade in the place where any part of performance is to occur shall be used in interpreting the agreement as to that part of the performance. U. C. C. sec. 1–205 (3)-(5) (1977).Google Scholar

68 Significantly, this “legalization” of community norms extends to the favored practices of local attorneys, as well as to the activities of their clients: “Attitudes toward conflicts of interest have changed fairly remarkably over the last 20 years, because of some local firms' increasing market shares. The leading Silicon Valley attomeys are able to work through what historically would have been very difficult conflict issues and get clients to say, ‘That's fine. We'll waive any conflicts. You can represent us both.’ Silicon Valley is, in a sense, transforming the law on that.”.Google Scholar

69 As this quotation suggests, early legal developments in Silicon Valley were, to a large extent, paralleled by developments in Boston's Route 128 corridor. Although the trajectories of the two regions have diverged somewhat in recent years (see, e. g., Saxenian, Regional Advantage (cited in note 22), Boston continues to boast several leading venture capital law firms. Given this, one historically important aspect of “mediating between Silicon Valley and the larger legal system” has involved mediating between Silicon Valley and Route 128. In the words of one San Francisco attorney who has been particularly active in national forums:. There are still differences in approach between the East Coast and the West Coast. But I don't think the differences are very extreme; they were greater initially. We were dealing with something new, and we each came up with our own ways of treating the problem. It was only as time passed that we became friends, and discussed things, and agreed on what the best ways to approach them were. For example, in the early 1970s I might have seen John Bartlett from Boston in two or three transactions. He had his way, and I had my way of doing things. Since that time we have become very close friends. As a matter of fact, I've reviewed a couple of books he's written and commented on manuscripts. So we have developed into a single national unit.Google Scholar

70 E. g., Francis S. Curie, “Legal Issues in Early Round Financing,”in B. Mann, ed., Venture Capital Financing: The Practical Aspects (New York: Practising Law Institute, 1988); Jacqueline Daunt, Venture Capital Strategies for High Technology Companies (Palo Alto, Cal.: Fenwick, Davis & West, 1989); Michael Halloran, Lee Benton, Jesse Lovejoy, Keith Kearney, & Robert Gunderson, Venture Capital and Public Offering Negotiation (Englewood Cliffs, N. J.: Prentice-Hall Law & Business, 1991).Google Scholar

71 This tabulation includes only the latest edition of each publication. Publication dates were not restricted, and the earliest recovered work bore a 1970 copyright. Silicon Valley authorship was determined by cross-referencing authors against the 1995 volume of the Martindale-Hubbell Law Directory. Google Scholar

72 Cf. Kathy Holub, “Larry Sonsini Goes Public,”San Jose Mercury News/West Mag., 26 Aug. 1990, pp. 16–29.Google Scholar

73 17 C. F. R. secs. 230.501-230. 508, 47 Fed. Reg. 11251 (16 March 1982). Regulation D exempts certain types of limited securities offerings from Securities and Exchange Commission registration requirements. According to the commission, Regulation D is “designed to simplify existing rules and regulations, to eliminate any unnecessary restrictions that those rules place on issuers, particularly small businesses, and to achieve uniformity between state and federal exemptions in order to facilitate capital formation.” SEC release 33–6389 (16 March 1982), cited in Richard D. Harroch, ed., Start-up Companies: Planning, Financing and Operating the Successful Business 4–9 (New York: Law Journal Seminars-Press, 1995).Google Scholar

74 E. g., Small Business Investment Incentive Act: Hearings on H. R. 3991 Before the Subcomm. on Consumer Protection and Finance of the House of Representatives Comm. on Interstate and Foreign Commerce, 96th Cong., 1st sess. 191 (1979) (statement of Bruce Alan Mann, Pillsbury, Madison & Sutro); Role of the Venture Capital Industry in the American Economy: Hearing Before the Subcommittee on International Trade, Finance, and Security Economics of the Congressional Joint Economic Committee, 97th Cong., 2d sess. (1979) (memorandum from Wilson, Sonsini, Goodrich & Rosati to the National Association of Venture Capitalists).Google Scholar

75 Committee members were:. M. Kenneth Oshman, Chair of the Task Force and President & CEO, ROLM Corp. Herbert M. Dwight, Jr., President, Spectra-Physics Inc. Peter J. Farley, President, Cetus Corp. Noel J. Fenton, President, Accurex Corp. John A. Gunn, Vice President, Dodge & Cox. Wallace R. Hawley, partner, InterWest Partners. Jack L. Melchor, Melchor Venture Mgmt. Inc. Robert N. Noyce, Vice Chair, Intel Corp. Henry E. Riggs, Chair, Dept. of Engineering, Stanford University. Mario M. Rosati, Esq., partner, Wilson, Sonsini, Goodrich & Rosati. Jerry Sanders, President, Advanced Micro Devices. Edwin V. W. Zschau, Chair, System Industries See Report of the Presidential Task Froce on Innovation and Enterpreneurship (5 Nov. 1980).Google Scholar

76 Cf. Gunther Teubner, ed., Jurification of Social Spheres: A Comparative Analysis in the Areas of Labor, Corporate, Antitrust and Social Welfare Law (Berlin: de Gruyter, 1987).CrossRefGoogle Scholar

77 These various forms of uncertainty absorption are, of course, interrelated and overlapping. Thus, for example, communitywide norms ascribe substantial symbolic value to transaction-specific activities such as taking stock in clients and drafting “businesslike” documentation-as well as to extracommunal activities such as authoring formbooks and serving on SEC advisory panels. Conversely, involvement in external professional and regulatory forums may prove essential to protecting the legality of ethically marginal transactional practices and to preserving the coherence of culturatly distinctive community norms.Google Scholar

78 Powell, 18 Law & Soc. Inquiry (cited in note 5).Google Scholar

79 Id. at 428.Google Scholar

80 Flood, 25 Law & Soc'y Rev. at 63 ff. (cited in note 5).Google Scholar

81 To a significant extent, even the national influence of the Silicon Valley bar was inadvertent, growing organically out of the day-to-day exigencies of practicing law in a new, distinctive, and rapidly expanding business community. The previously quoted founder of the ABA Emerging Growth subcommittee, for example, portrays his career trajectory as largely coincidental: “I got involved in venture capital by accident. The Snowmass Conference was very, very high profile, and so what followed was chat I was invited to give a lot of speeches. I chaired programs all over the world on venture capital, and my career shifted. I just became a part of that world. Venture people became a part of my life.”.Google Scholar

82 Cf. Michael E. Porter, Competitive Strategy (New York: Free Press, 1980); Paul Lawrence, “The Harvard Organization and Environment Research Program,”in A. Van de Ven & W. Joyce, eds., Perspectives on Organization Design and Behavior 311 (New York: Wiley, 1981); DiMaggio & Powell, 48 Am. Soc. Rev. (cited in note 64).Google Scholar

83 Indeed, as one anonymous reviewer has noted, by routinizing specific transactions and by reducing communitywide uncertainty, Silicon Valley lawyers may be working themselves out of their jobs-or at least out of those aspects of their jobs that are most distinctive relative to the legal profession as a whole.Google Scholar

84 Cf. Arthur, 99 Econ. J., and 262 Sci. Am. (both cited in note 31); David, “Economics of QWERTY” (cited in note 31).Google Scholar

85 Cf. Hirsch, 77 Am. J. Soc. (cited in note 40).CrossRefGoogle Scholar

86 Indeed, given the ethical questions raised by Silicon Valley lawyers' departures from conventional practice, one might well argue that the community would operate more efficiently if its lawyers were less facilitative and more adversarial.Google Scholar

87 Although a growing strand of revisionist economic history recognizes path dependence as a central feature of economic life (e. g., David, “Economics of QWERTY”), mainstream economics continues to rely heavily on assumptions of general equilibrium. Accordingly, traditional transaction cost analysis (especially as manifested within the law and economics movement) tends to assume that stable social systems are necessarily efficient, that efficient social systems are necessarily stable, and that competition and rational choice will necessarily drive social systems to stable efficiency in a direct and expeditious fashion. In general, however, these assumption are more matters of faith than conclusions from evidence, and the present study does not change this state of affairs. See Mark, Suchman, “Translation Costs: A Comment on Sociology and Economics,” 74 Ore. L. Rev. 257 (1995).Google Scholar