The Endowment Effect and Drafting Contracts

An article on the possible evolutionary origins of the endowment effect in this week's Economist says near the end:

The [endowment] effect also complicates the negotiation of contracts, as people demand more to give up standard provisions than they would have been willing to pay had they bargained anew.

This is so true. When negotiating a contract for a client, a somewhat common strategy among transactional lawyers is to draft a contract heavily tilted towards your client to use as the template in the negotiations. That way, when the other party is attempting to strike or modify a provision that favors your client, he thinks he's securing a much more valuable concession than he really is. In other words, the endowment effect works the other way too: if the other party thinks a provision tilted towards your client is normally included in a standard-form contract, he'll pay more to modify the provision than he would have been willing to pay for the modified provision had the contract been negotiated from scratch.

When I'm drafting a contract to use as a template in the negotiations, I always put the most important provisions that are tilted towards my client at the end (usually dealing with liability), and the least important provisions that are tilted towards my client at the beginning (usually dealing with the timing of payments). That way, when we're going through the contract in the initial negotiation, the other party gets to successfully strike or modify a bunch of provisions he thinks are unfair right at the beginning. Then by the time we get to the end of the contract (where the most important provisions tilted towards my client are), the other party thinks he's already secured a bunch of valuable concessions, and is much less aggressive about striking the important provisions. When the other party is the seller (which is usually the case in my practice), sometimes he's actually willing to drop the final sale price in exchange for striking or modifying one of the important provisions at the end of the contract.

Of course, this only works when the other party doesn't have an experienced lawyer representing him. In that case, we usually spend a good bit of time arguing over whose draft contract we're going to use as the template. But if the other party is represented by a lawyer with little experience in the particular field, you'd be surprised how well this works.