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Adding Value to the Deal learn how more experienced practitioners think.

The framework consists of five

prongs, each of which is
a business issue that appears in almost every transactionalbeit in different
Drafting contracts is more than translating the business deal into contract guises. The prongs of the
concepts and writing clear,
framework are as follows:
unambiguous contract provisions. Sophisticated drafting requires a lawyer to
understand the transaction Money.

from a clients business perspective and to add value to the deal. Looking at a Risk.
contract from the clients
perspective means understanding what the client wants to achieve and the risks it
wants to avoid. Adding Standards.

value to the deal is a euphemism for finding and resolving business issues. These Endgame.
skills are problemsolving
The subsequent sections of this chapter discuss these prongs and show how they
skills and are integral components of a deal lawyers professional expertise. They manifest themselves in
require an
transactions. Afterward, you will work through a series of exercises in which you
understanding not only of contracts, but of business, the clients business, and the will apply the fiveprong
transaction at hand. At a
framework to fact patterns.
law firm or general counsels office, having these skills is generally the province of
the senior lawyers, 25.2 MONEY

and not necessarily all of them. 25.2.1 AMOUNT TO BE PAID OR RECEIVED

In a totally unscientific survey, partners were asked how they identified business The first money issue to consider is always whether a client is entitled to receive
issues. The following more money or to pay

are some of the responses: less. Although clients generally negotiate and agree on the amount, lawyers can
often add value because
Identifying business issues requires a sixth sense.
of their deal-specific expertise. For example, perhaps your client, a major bank,
A business issue is any issue you find that the client should resolve. wants to purchase a

I know one when I see one. corporate jet. The clients expertise is finance, not the purchase and sale of
airplanes, which is your
The nub of these answers is that the partners learned by experience how to
discern business issues. specialty. If the client consults you before it negotiates the purchase price of the
plane, you may be able to
Although you will find no substitute for experience, this chapter proposes a
framework that will help you add value by explaining that the planes proposed purchase price exceeds current
market value because of
the glut of planes on the market. your client whether it could benefit from an immediate but smaller payment. For
example, if the client
As part of this analysis, consider whether any of the payment should be
contingent. For example, buyers receives the funds immediately, it may be able to invest in a new deal.

and sellers may value a sellers business differently. This is especially true for a 25.2.3 CREDIT RISK
new business. The seller
Credit risk is always a business issue when the other party is obligated to pay your
is sure that it is the next Google, and the buyer certainly hopes so but questions client in the future.
the sellers valuation
Although the other party may be flush with cash when the parties make their deal,
because the business has no track record of profitability. To bridge the difference it may be less strong
in valuation, a buyer
when payment is due. Therefore, whenever your client has agreed to receive a
can pay the seller a small amount at closing and additional payments in the future. delayed payment, consider
The parties will
whether the risk of a payment default is significant. If it is, then negotiate a
determine that amount based on a formula tied to the businesss performance mechanism to secure the
after the acquisition. This
arrangement is known as an earnout.1
Parties often use a formula to determine a contracts consideration. For example,
When analyzing a transaction, think through any issues with respect to the timing formulas are used to
of monetary payments.
calculate the following:
These are known as time value of money2 issues. It is almost always better for a
client to pay later, but to Purchase price adjustment provisions in acquisition agreements.

receive money sooner. The longer a client has the money, the longer that money Compensation provisions in employment agreements.
can be invested and
Royalty provisions in license and franchise agreements.
earning money. (Of course, tax considerations or other matters might require
postponing the receipt of Buy-out provisions in partnership and stockholder agreements.

money.) When reviewing a formula, begin by analyzing whether the theoretical basis for
the payment amount is
If your client must pay the other party, ask whether it can spread out the payments
over time, or whether analytically correct. Stated differently, is the formula neutral, or does it favor your
client or the other
the other party will give your client a discount for immediate payment. If the other
side must pay your party?

client, negotiate for receipt of the payment as soon as possible. If the other side Buchwald v. Paramount Pictures Corp. brought the problem of a flawed formula
objects, find out from into sharp relief.4 That
case made Hollywood accounting infamous. The trouble began when Alain plugged into the formula. Be sure to include in the hypotheticals numbers far
Bernheim, the producer of outside the range that the

Coming to America,5 agreed that Paramount would pay him a percentage of the client expects. Calculations sometimes result in negative amounts, and the parties
movies net profits, in need to address what

addition to a modest upfront fee. Apparently, Bernheim expected the movie to be happens in that circumstance.
a success and
After running the numbers, send the hypotheticals to your client to make sure that
anticipated that he could earn much more money by receiving a percentage of net he understands how the
profits rather than a onetime
formula will work, both when the transaction succeeds and when it fails. (Clients
upfront fee. do not like surprises.)

The movie was a huge hit. Bernheim, no doubt, was elated. Unfortunately, that Once your client approves the formula and the hypotheticals, send them to the
elation was short-lived: other side for its review

The studio reported that it lost money on the movie and that Bernheim was and approval. With luck, this process will root out any differences at a time when
entitled to no additional they can be resolved

money. The problem stemmed from the way the studio accounted for the movies without litigation. As the final step in this process, with the approval of all the
expenses. It included as principals, annex the

expenses not only the direct expenses of the movie, but also some of the studios hypotheticals as an exhibit to the contract. They will become a legislative history of
overhead expenses. sorts, setting forth the

Thus, Bernheim would have been far better off receiving a percentage of the parties understanding of the formula at the time of contracting.
movies gross revenues
before any expenses were deducted. Alternatively, Bernheim and the studio could
have agreed on which Parties do not always address the allocation of transaction expensesespecially
at the preliminary stages
expenses were allocable to the movie.
of negotiation. As they can run to a tidy sum, you and your client should think
Assuming that your client and the other party have agreed on a formula for through whether each party
calculating the payment
should pay its own expenses or whether the expenses should be shifted from one
amount, confirm that the formula is properly stated. Is each variable party to the other.
unambiguous? Is the formula as a
whole unambiguous?
The accounting and tax issues in a contract can be quite sophisticated. These
Some of the most common drafting errors occur when crafting a formula.6 To issues may determine the
make certain that a formula
structure of the transaction and sometimes even whether the transaction can be
works as intended, run multiple hypotheticals to see what answers are obtained done. If you do not have the
when numbers are
background to address these issues, you must obtain the assistance of a qualified mechanisms. In addition, risk can manifest itself in multiple other ways in a
practitioner.7 transaction. First, a contract

25.2.7 WHO, WHAT, WHEN, WHERE, WHY, HOW, AND HOW MUCH? can raise the specter of tort liability fraudulent inducement, product liability, and
tortious interference
As you may recall from Chapter 8 on the action sections, whenever you draft a
provision dealing with the with contract. Second, the provisions can create contract law risk. For example, a
payment of money, you should always answer the questions, who, what, when,
where, why, how, and how provision could be unenforceable. Third, a contract can create statutory liability,
such as liability under
the securities laws. Fourth, a risk, such as credit risk, can be inherent in the
25.2.8 ENDGAME transaction.

Every contract endseither happily or unhappily. A borrower can repay the loan 25.3.2 EVALUATING THE RISK
or default; a joint
Lawyers are terrific at ferreting out risks in a transaction. Law school primes them
venture can conclude successfully or fail; and an acquisition can close or fail to be to issue spot. If that is
consummated. No
all they do, however, they will quickly earn justifiable reputations as deal killers.
matter which way a contract ends, the parties will have issues to address. Often,
they include money. Determining the risks only begins a lawyers risk analysis. Next, she must assess
the probability that the
Therefore, when drafting endgame provisions, think through what should be the
monetary consequences of risk will occur. In addition, she should try to quantify the risk and do a risk/reward
analysis. With this
the contracts end. Follow the cash. For example, when a real estate lease term
ends, consider what information, the client can evaluate the risk more completely. It may decide, for
example, not to elevate
should happen with the tenants deposit: The landlord should be required to return
it, but should be able to the matter to a business issue because it believes that the risk will probably not
occur and that the
offset against it any costs incurred because of the tenant damaging the
apartment.9 financial consequences would be relatively small. Alternatively, the client could
decide that the benefit
Monetary endgame issues also include whether the prevailing party in a litigation
should be contractually does not justify the risk, even with a low probability of occurrence.

entitled to recover its attorneys fees and other litigation expenses.10 Whether a risk develops into a business issue often depends on a clients risk
aversion profile. How
25.3 RISK
comfortable is the client with taking risk? Is the client an entrepreneur ready to roll
25.3.1 TYPES OF RISK the dice, or is it a

As we have seen, representations and warranties, covenants, and conditions are small, local bank willing to assume only minimal risks?
all risk allocation
A lawyers reputation as a dealmaker often depends on his ability to resolve risk In a letter of credit transaction, a bank substitutes its credit for that of a partys. For
issues creatively. example, imagine a

Although a transaction may require an innovative solution, you can often rely on manufacturer in Italy wants to sell goods to a small company in New York but will
the techniques discussed not do so unless it can

in this section. be assured of payment. To provide this assurance, the buyer arranges for a letter
of credit under which a
If credit risk is the concern, one party can take a security interest in the other
partys assets. If you use this bank will pay the manufacturer on the fulfillment of certain conditions.

technique, determine which assets are the most valuable and which will be the Typically, the conditions require that the manufacturer deliver documents to the
easiest to liquidate. Be bank indicating that the

sure that the security interest applies to these assets. As an alternative (or proper goods are being shipped. The bank does not, however, undertake to
additional) technique for inspect the goods. It only

reducing credit risk, a third partys credit can be added to the credit of the party examines documents.12 If the buyer wants an inspection of the goods, the buyer
with the payment must arrange for a third

obligation. Typically, the third party will agree to serve either as a co-obligor or as party to inspect the goods and issue a certificate that the inspected goods were
a guarantor. Of the proper items in the

course, this party must be creditworthy. appropriate condition.

Escrows are another technique that parties use to lessen credit risk. To create an After all the parties have agreed to the conditions, the bank issues its letter of
escrow, the parties credit in favor of the

deposit cash or other property with a neutral third party, who agrees to release it manufacturer. The letter of credit is the banks promise to pay the manufacturer on
only in accordance with its presentation to the

the terms of the escrow agreement. The Exhibit to the book discusses escrow bank of the appropriate documents. Thus, the bank substitutes its credit for the
agreements, including their buyers. The buyer

use and some of the salient business issues.11 reimburses the bank after it pays the manufacturer.

Other methods of reducing risk include indemnity agreements, letters of credit, Parties also use insurance to reduce risk. Companies generally purchase multiple
insurance, and dealspecific kinds of insurance.

methods. In an indemnity agreement, one party promises to pay the other party for General liability insurance.
its losses,
Directors and officers insurance.
even if the indemnified party did not cause the loss. For example, when a lateral
partner joins a firm, the Health insurance.

firm generally indemnifies the lateral partner against any existing malpractice Environmental insurance.
Business interruption insurance.
Knowing that a party has insurance is insufficient. You must know, among other want the ability to protect their investment. Thus, the limited partners will seek as
things, the deductible (the much control as the

amount the insured must pay before the insurer is liable), the maximum the general partner will tolerate and as much control as the limited partners can
insurer is obligated to pay, accrete without becoming

how much of that amount has already been paid, and whether the insurer is general partners under the relevant state law. Thus, control is actually a two-
creditworthy. edged sword for limited

As noted, parties sometimes need to rely on deal-specific methods to reduce risk. partners.
For example, the
Control is always an issue when your client is subject to a risk. Indeed, whenever
parties could reduce a buyers risk by changing a stock acquisition to an asset your client worries
acquisition. The risk is
about risk, ask yourself how the agreement can diminish or control it.
reduced because of the different structure. In an asset acquisition, a buyer
chooses which assets it will Control and risk business issues often coexist when negotiating and drafting
covenants. With respect to
buy and chooses which liabilities it will assume. If the buyer does not specifically
assume a liability, it each promise, determine whether your client can control the outcome. If not, it is
gambling when it agrees
remains with the seller. So, if the seller had significant litigation liabilities, the
buyer could choose not to to the covenant because it could end up in breach through no fault of its own. To
protect your client,
assume those liabilities. In contrast, in a stock acquisition, no assets are assigned
or liabilities assumed. negotiate a covenant that reduces the risk by changing the degree of obligation.
For example, a party may
Instead, the shareholders of the target sell their shares to the buyer who becomes
the new shareholder. not want to promise that it will obtain an environmental permit because it cannot
control the agencys
Nothing happens to the business. Thus, any liability of the target continues to be
its liability. Only its decision. That party may be willing, however, to promise that it will prepare and
submit the necessary
shareholders have changed.
papers by a certain date and that it will enter into good faith negotiations with the
25.4 CONTROL agency.

In analyzing control as a business issue, the initial inquiry must be whether having When thinking about control issues, think through which party is in control,
control is good or bad whether that is the correct

from a clients perspective. For example, limited partners are entitled to limited party, or whether control should be shared, and if so, how. Imagine two
liability because they companies have entered into a

exercise no control over the limited partnership. In this context, lack of control is joint venture to build a skyscraper. Should one party decide (that is, control) who
good. However, limited the subcontractors will

partners do not generally want to abdicate to the general partner all control over be? If the decisions are to be joint, how will the parties break a deadlock?
their investment. They
Once controls are in place, they need not remain at the same level throughout a standard to be incorporated into a loan covenant). Thus, each time a definition
relationship. For example, changes, so do a partys

after first making a loan, a bank may justifiably insist that the agreement prohibit rights and duties.
the borrower from
Once you determine what the standards are, determine whether the standard
making any capital expenditures. The bank has made the loan for working capital favors your client, and if not,
purposes and does not
how it can be modified.
want the loan proceeds sidelined into fixed assets not immediately involved in
producing profits. Some drafters insist that vague standards are inherently wrong.13 That is
incorrect. While vagueness may
However, the bank may be willing to moderate this restriction once the borrower
has repaid an agreed-on invite a dispute over a standard, sometimes it is the only way to bridge disparate
positions or to provide a
percentage of the principal.
party with flexibility. Vagueness is the drafters equivalent of the reasonable
Parties can also increase controls. Preferred shareholders often negotiate for this. person standard. Parties use
Generally, they have no
it to establish a facts and circumstances test. For example, if a force majeure
voting rights. But if the parties agree, they could earn the right to have one or event occurs, how quickly
more board members if the
must the nonperforming party tell the other party of the occurrence? Immediately?
company fails to pay dividends for three consecutive quarters. Within 24 hours? What

25.5 STANDARDS if the nonperforming party is cut off from all communication because of the force
majeure event? Under
Almost every word or phrase in a contract establishes a standard. For example,
every representation and those circumstances, the 24-hour cutoff is unreasonable. More equitable would be
as soon as feasible.
warranty establishes a standard of liability. If the standard is not met, the recipient
of the representation Although vague standards may sometimes further a transaction, they can also
disadvantage a client. It
and warranty may sue the maker. This is a macro standard. That macro standard
can, however, be changed depends on the business deal. As noted earlier, sometimes a seller of a business
will agree to an earnout.
at the micro level. By changing a word or a phrase in a representation, the
standard changes. Are To memorialize this arrangement, the purchase agreement will state the formula
for determining the
property, plant, and equipment in good repair, customary repair, or in compliance
with statutory income on which the earnout is based. The value of the sellers earnout could be
destroyed, however, if
standards? Covenants and conditions are also standards, as is every adjective
(good repair) and adverb that formula merely states that revenues minus expenses equals income. In that
case, the vagueness of the
(promptly deliver). Definitions are also standards (how a financial ratio is defined
determines the standard expenses would permit the buyer to decrease the income by deducting
inappropriate expenses.
Therefore, do not start drafting with a preconceived notion that vagueness is good These critical provisions deserve your studied attention.
or bad. Instead, each
time a provision establishes a vague standard, analyze whether it helps your client
or whether a more 30.1 INTRODUCTION

specific, concrete standard would improve the clients position. The ABA Model Rules of Professional Conduct (the Model Rules)1 primarily
address ethical issues
When you contemplate negotiating a change in a standard, think through the
business risk of asking for that that arise in litigation. This focus creates problems for deal lawyers who turn to
them when faced with
change. If your client has limited negotiating leverage, a request for a change will
focus the other partys ethical dilemmas. They find, with limited exceptions,2 no rule on point or one that
applies only
attention on that standard and could result in an even more stringent standard.
tangentially or by analogy.
You and your client must also consider who should decide whether a standard has
been met. Sometimes, a The litigation bias of the Model Rules has its roots in the failures of its
predecessors, the Model Code of
party decides. For example, a landlord and tenant could agree that the tenant may
assign the lease to a Professional Responsibility3 and the 1908 Canons of Ethics:4

third party, but only if the landlord grants consent in its sole discretion. The [Model] Codes failure to state standards and objectives for the advisor is
probably due to
If the parties disagree as to whether a standard has been met, they have several
options. They can many factors. Perhaps the most easily understandable is historical. Traditionally
the lawyers function
adjudicate the matter in court, or they can arbitrate or mediate their disagreement.
Alternatively, they can was almost solely that of a courtroom advocate, and as a result, the original
Canons of Professional
appoint an individual with subject matter expertise to resolve any disputes outside
a proceeding. In Responsibility [1908] dealt almost exclusively with the dilemmas of that role.

sophisticated construction agreements, owners and contractors sometimes Several reasons help explain why this historical bias has not been remedied.
appoint a third-party engineer While the result of

to settle any differences in a timely mannersometimes in just a few days. the advocates effort is often of extreme public import, and occasionally political in
nature, the advisors
Contracts, sometimes, but not always, address the consequences of breaching a
standard.14 effort is generally private and seemingly important only to the immediate parties.
Frequently the advisors
most important decisions are designed to remain confidential. Because the Model
As noted earlier in this chapter and as discussed in Chapter 15, every contractual Rules serve partly as a
relationship terminates
public relations device, it is only natural that the Rules should focus on the more
in either a friendly or an unfriendly manner. Either way, the parties must think public, and more
through the consequences.
publicized, role of an attorney. representation.6

Another reason for the limited viewpoint is that the advocates role has been Stated more colloquially, the clients role is to establish the representations
better defined objective, while the

by a well-delineated legal process. In contrast, the advisor performs many diverse lawyers role is to determine the means to accomplish the objective and to take
functions for the client the actions necessary to

and generally is unconstrained by formal procedures. As a result, it is more accomplish it.

difficult to state
Comment 2 to Model Rule 1.2 adds a gloss on the objective/means dichotomy in
comprehensively the ethical considerations for an advisor.5 the context of a lawyer

Exacerbating this paucity of rules is a paucity of case law and ethical opinions. and client disagreeing about the means the lawyer should use. Although the
This scarcity Comment does not state how

undoubtedly reflects the private nature of transactional work. Litigation is audible, lawyers and clients should resolve their disagreements, it notes the following:
visible, and publicit
Clients normally defer to the special knowledge and skill of their lawyer with
takes place in a forum where the proceedings are recorded. Transactions are respect to the means
generally negotiated in the
to be used to accomplish their objectives, particularly with respect to technical,
privacy of a conference room, and contracts drafted in the privacy of an office. legal and tactical matters.
Because no record is
Conversely, lawyers usually defer to the client regarding such questions as the
made, disciplining a lawyer becomes much more difficult. expense to be incurred and

The remainder of this chapter highlights key ethical issues that contract drafters concern for third persons who might be adversely affected.7
face. The
This gloss carefully hedges its assertion by including the adverbs normally and
exercises at the end of the chapter take you past the generalities to specific, real- usually. In the
world applications of the
transactional context, the glosss applicability depends to some degree on the
ethics rules. clients sophistication. The

30.2 THE DRAFTERS ROLE more sophisticated the client is, the more likely that the client will want to
participate in technical, legal,
Model Rule 1.2(a) allocates the responsibilities and authority of lawyers and their
clients. It states: and tactical matters. Sophisticated clients often have as much experience as their
lawyers in negotiations
[A] lawyer shall abide by a clients decisions concerning the objectives of
representation and, and will have specific ideas on what to broach, how, and when. In addition, as
more lawyers have moved
as required by Rule 1.4, shall consult with the client as to the means by which they
are to be pursued. A out of the legal profession into business positions, more clients have legal
expertise. In these situations,
lawyer may take such action on behalf of the client as is impliedly authorized to
carry out the
deferring to the client as to the means is appropriate. If you vehemently disagree The italicized words are the key. You may represent a client despite little practical
with the clients experience, but only if

decisions, consider resigning.8 you gain the requisite knowledge through study. For a contract drafter, requisite
knowledge means, at a
Although no Model Rule deals directly with contract drafting, the objective/means
dichotomy does bare minimum, a thorough grounding in contract law. (E.g., You should know the
consequences of drafting
provide some guidance as to the drafters role. That role is to facilitate, through
drafting (the means), an a covenant rather than a condition.) In addition, according to some commentators,
it includes an
agreement between the parties (the clients objective). But this role does not
render the drafter a mere understanding of arbitrations role in dispute resolution.11 It also entails subject
matter expertise either
scrivener. By working with a client to flesh out the business deal, a drafter adds
value to the deal and in a field of law or an industry. Finally, you must understand business, including
financial statement
advances the clients objective. A drafter may not, however, recut the parties
business deal by adding or concepts.12 You cannot draft an agreement reflecting a business deal if you do
not understand business and
changing provisions to which the parties have agreed. Doing so steps over the
line. the clients business. Remember: A failure to have (or gain) the requisite expertise
could subject you not
only to disciplinary action but also to malpractice liability.
Model Rule 1.1 states that [a] lawyer shall provide competent representation to a
client.9 This rule A drafters responsibilities also include regularly informing the client about the
status of the agreement
raises at least two issues for drafters. First, what body of knowledge must a drafter
have to be competent, and the transactionhow business and legal issues have been resolved and
which issues remain open.13
and second, may a lawyer draft a contract if the lawyer has no prior experience
with that type of contract? What this entails varies, depending on what Comment 5 to Model Rule 1.4 calls
the guiding principle:
Comment 2 to Model Rule 1.1 should give you some comfort as you begin your
career: The degree of communication depends on the clients expectations.14 Some
clients are hands-on and want
A lawyer need not necessarily have special training or prior experience to handle
legal problems of to know everything about everything. Other clients are concerned only with the big
picture. They want
a type with which the lawyer is unfamiliar. A newly admitted lawyer can be as
competent as a information on deal points, but not on other, subsidiary business issues. What and
how much you
practitioner with long experience . A lawyer can provide adequate
representation in a wholly novel communicate is client specific.

field through necessary study.10 (Emphasis added.) 30.4 INTERACTIONS WITH THIRD PARTIES
Transactional lawyers deal with third parties on a regular basis, particularly in D, when the clients actions are criminal or fraudulent, the lawyer violates the
negotiations. These ethical duty not to assist a

dealings are often strewn with ethical landmines through which you must navigate client in criminal or fraudulent activities.
carefully, and they do
To apply the concept of intersectionality to drafting, imagine that the diagonal
not disappear because you are negotiating on paper through dueling drafts and represents varying degrees
of truthfulness in the clients representations and warranties. If the representations
The key ethical proscriptions in connection with contract drafting are the following and warranties are true,
Model Rules:
then the lawyers drafting of the contract does not violate any ethical proscriptions.
Model Rule 1.2(d) A lawyer shall not counsel a client to engage, or assist a But, if they are
client, in conduct
intentionally false, they constitute fraudulent misrepresentations, and drafting the
that the lawyer knows is criminal or fraudulent .15 contract assists the client

Model Rule 4.1(b) In the course of representing a client a lawyer shall not in perpetrating a fraud.
knowingly fail
Violation of Model Rule 8.4(c) does not require as a prerequisite that the client
to disclose a material fact to a third person when disclosure is necessary to avoid commit a crime or fraud.
assisting a criminal or
Instead, the focus is on the lawyers actions. Has the lawyer done something,
fraudulent act by a client, unless disclosure is prohibited by Rule 1.6.16 independently of the clients

Model Rule 8.4(c) It is professional misconduct for a lawyer to engage in actions, that involves dishonesty, fraud, deceit, or misrepresentation? For
conduct example, one ABA Opinion

involving dishonesty, fraud, deceit or misrepresentation .17 concludes that a lawyers failure to alert the drafter of a scriveners error that the
latter made would
Model Rules 1.2(d) and 4.1(b) require an understanding of intersectionality.18
Intersectionality constitute fraud by the lawyer.19 Although the opinion also adverts to Model Rules
1.2(d) and 4.1(b), the
determines whether a lawyers actions are ethical by looking at where in the
spectrum of behavior the violation of Model Rule 8.4(c) is included as a separate violation.

clients actions fall. Imagine that the following diagonal represents the range of a
clients actions, moving

from legal and not fraudulent at Point A to criminal and fraudulent at Point D.

As the clients activities move down the diagonal, the lawyers actions move in
tandem from ethical to

unethical. So, at Point A, when the clients actions are legal, his lawyers actions
are ethical. But at Point