On a European System of Contract Law

By: Bathélémy Mercadal

Law Professor in French Universities

Honorary Professor at the Conservatoire National des Arts et Métiers (Paris).

Vice President of the Institut du Droit d’Expression et d’Inspiration Française.

1. The system of contracts and obligations is a very hot issue within the European Community today. A call to impose new rules has been made by those who point out to the old nature of that system and to the diversity of the Community which now has 25 members. France, in particular, has denounced this lagging behind. In that country obligations and contracts are still ruled by the Napoleon Code, in effect since March 21, 1804, just as in Belgium. The code, known since then as “Civil Code” remains practically unchanged in obligations and contracts: out of 289 articles forming this field, 261, that is to say over 90%, have retained their original form; 8 articles have been repealed and the amendments made to the others have not caused any major repercussion.

The European Commission has seen the diversity of the European Community as an obstacle to a full development of the domestic market and has called for proposals to modernize and to unify the system.

This has lead to two drafts, privately generated, known as “Principles of European Contractual Law” directed by Professor O. Lando, and the draft European contract code, by the Academy of European specialists in private law, directed by Professor G. Gandolfi.

2. At least in appearance, great changes are getting ready to take place in the European system of obligations and contracts. The IABA authorities have shown an interest in this subject and it is for me an honor to accept the invitation to deliver the present paper. The curiosity of jurists of the American continent is justified, for two reasons: on the one hand, you apply laws inspired by European rules, whether from the civilian or from the common-law tradition, two legal systems destined to melt into the common rules of a European contractual law; on the other hand, economic transactions between the American and European continents are such that the events taking place in the Atlantic community make a practical impact on your activity as a natural result.

In order to expedite this presentation, let us assume that the definition of a European contractual system orbits around the following four questions:

What reasons justify such endeavor?

What fundamental options do we have?

What new content may emerge?

What choices should be made?

I.- What reasons?

I-1. The proponents of this project state four reasons, which are contested by those having a different view.

I-2. Assuring an internal market. The European Commission considers that the creation of a single market by members of the Community implies the multiplication of contracts among subjects from different States, contracts considered transnational, particularly between corporations and consumers and between small and medium enterprises as well. For the Commission the divergence of contractual rules prevent an expansion of these contracts. But the European Counsel of Heads of State has requested the Commission to furnish evidence of such hindrance, and for the moment, the Commission hasn’t provided any evidence.

While waiting for such response one might enquire if it is realistic to envisage an important turn out of transnational contracts between consumers and enterprises, the latter usually making the effort to approach the former to enter into a contract in the country where the consumer is domiciled and according to his legal system. Only electronic commerce B to C will develop such contracts. But to address these needs there is a directive, 2000/31, on electronic commerce.

On the other hand, transnational contracts could be more current among small and medium enterprises; however, it remains unclear whether they are hindered more by Europe’s lack of commercial dynamism than by the existence of different legal systems.

I-3. The legibility of contract law. It is difficult to understand contract law, even if written, when it is largely composed of judicial decisions which have distorted the statutes to keep pace with social changes. To be sure, this reproach is addressed at the common law. But it also reaches French law, of which a great part can now be found in decisional law. The Principles of European Contract Law include the term “reasonable”, or its derivatives, 61 times in 129 rules, or 47% in all. Does a general rule limit contractual freedom with the demands of good faith? What can the practicing attorney do to know what is reasonable and what is good faith but to check what case law says?

I-4. Supressing the differences between the two systems. In the first place it should be noticed that the differences concerning national public policies (ordre publics nationaux) are the most glaring. The argument is clear and strong in theory. In practice its reach is limited. Concerning transnational contracts, which are international contracts, public policy plays a limited role since national public policy is not automatically applicable to international contracts. For instance, a systematic study of French published decisions indicates that the following have been determined to be public policy rules: the tolling of the statute of limitations running against a minor; the contractual waiver of liability for fraud or gross negligence; and staying individual actions against a debtor under bankruptcy protection.

In the second place, it has been observed that different jurisdictions have divergent approaches to flexible concepts, particularly that of good faith which is judged more rigorously in certain member States than in others. However, since the new Principles draw heavily from the notions of good faith and of reasonability, it should be expected that in applying said Principles courts will adopt divergent approaches. Within different jurisdictions of a single State the meaning of what constitutes good faith and what is reasonable varies unpredictably.

I-5. The cogency of contractual law. We all know that civil-law jurists continually strive to achieve a conceptually logical system, built to perfection. Common-law jurists, on the other hand, accept the realism of justice through case law where justice follows the demands of each specific case.

In our view this difference is more apparent than real. The rules crafted as a system don’t resist the test of facts and are adapted by judges. At the same time, the decisions rendered under the common law end up forming a set of rules based on precedent. In civil law one cannot apply a statute without researching case law. Does one do differently in the common law when one looks for the controlling rule through a series of precedent? Under both systems, a party to litigation tries to convince the court of what another judge has previously decided in a given sense, while the adversary party tries to show that the decision in question is not really applicable to the case at bar.

Besides, the quest for an intellectually coherent common thread would be vain. After all, law materializes through justice and the latter is not guided by logic but by the balance of antagonistic interests. In this sense justice is symbolized by a balance tending towards equilibrium rather than by a sliding ruler.

II. What options are there?

II-1. To create a new system of contract law we must focus on the fundamental values on which it will be based. Historically we can see three values present in obligations and contracts.

II-2. Legal certainty. A contract is an act of foresight which, when concluded, attempts to capture what the parties believe the future will yield. It holds a bet about what may happen. When consent is exchanged the parties stand by the text of the contract, with its ink still fresh. Experience shows that during performance divergences as to the meaning of the text creep in. Then, one party upholds the literal meaning while the other pleads about its spirit. Which of these two conflicting views should take precedence?

II-3. Contractual justice. Some argue that a strict interpretation of contractual clauses gives due respect to what has been agreed to. Otherwise the faith placed on the contract would be betrayed and that in itself would ruin the economic objective of the contract. That justifies the French Civil Code tenet according to which a contract is law between the parties.

Others think that not a static notion of a contract but a dynamic conception should be applied. The common interest of the parties should prevail over a strict, literal interpretation. The contract then should be performed according to the parties’ common interest and not yielding to the interest of one party over another, even if the letter of the contract would seem to indicate differently. In France this idea is represented by the word “solidarity” (solidarisme): each contracting party should care for the interests of the other instead of taking an exclusively selfish position.

II-4 Formulating the rules. Here the problem arises between the generality of a principle and the precision of a regulation. The choice between these two terms underscores the tension between a rule trying to reduce the judge’s power of interpretation and a trend that gives him wide latitude to reach a solution that he deems fair. This contradiction is illustrated by article 1134, para. 3 of the French Civil Code, which in 1804 proclaimed: “contracts are to be performed in good faith”. That opened the door to a series of adaptations allowing this question on the state of French law, which speaks volumes about what an open text allows, “Loyalty, solidarity, fraternity, the new contractual banner?” (D. Mazeaud, Mélanges F. Terré, Dalloz, PUF, Editions du Juris-Classeur 1999, p. 603).

II-5 Contractual universalism. Is it necessary for contract and obligations law to be uniform in order to allow a harmonious and fluid economic exchange across borders? Some people believe this to be an obvious truth. It could be objected, however, that different legal systems have not prevented the movement of globalization, nor have they posed an obstacle for the European Common Market to become what it is now. Contract law tends towards universalism because its objective is the same everywhere: to render the parties’ pursuit compatible. Is it then possible to achieve a universalism through systems that are radically different from each other? Certainly, fairness is elusive and difficult to formulate. But no system rejects contractual justice. The French Civil Code rejects the theory of unconscionability and reformation based on unforeseeability, but this has not prevented the acceptance of loyalty, solidarity and fraternity principles, as stated above.

III- What content?

III-1 Proposals. These are not in short supply. Legal theory has successively received: a lex mercatoria created by arbitration of international contracts, the UNIDROIT principles for international business contracts, the Principles of European contract law created by the so-called Lando Commission, and the European Contract Code by the Academy of European private-law specialists.

Judging from a list made by Lord Mustel (Journal du Droit International, 1989, p. 324 and fol.) some rules appear -19 precisely- which have been adopted in France as representative of civil law. Given their purpose and the common-law background of their author one may think that these rules are widely applied the world over. Here is a sample of the main rules: basically, contracts should be performed according to their clauses: pacta sunt servanda; the principle of pacta sunt servanda is limited by the exception of “rebus sic stantibus”, taking into consideration contracts of a long duration; pacta sunt servanda must also be limited by the concept of abuse of rights and by the rule that unconscionable contracts should not be performed; the theory of “culpa in contrahendo”; the duty of performing contracts in good faith; one party’s obligations may be considered discharged when the counterparty has breached his, but only if said breach is substantial; neither of the parties is authorized to cause the failure of the condition for performance through his own acts to affect his own obligations; a court is not bound by the way in which the parties classified the contract; damages for breach of contract are limited to the foreseeable consequences of the breach; a party who suffered damages for a contractual breach has the duty to take reasonable steps to mitigate; each party must be diligent to protect his interests.

These rules are practically restated in the Unidroit Principles and in the two European drafts on contracts which, additionally propose a rule for unilateral termination of the contract by giving notice of the termination or of the nullity of the contract, at one party’s initiative.

Generally speaking, there isn’t much one can add about the majority of these notions that can’t be found in most of the different national systems of contract law. Anyway, one cannot judge their merit without knowing how these notions have been effectively applied.

II-2 Reception. For the moment we are not aware of any application of the Lando Principles of European Contract Law. However, what can be assessed is the effect of the lex mercatoria and of the Unidroit Principles.

According to a study on awards rendered by the International Chamber of Commerce following arbitration rules (E. Jouvet, Arbitral Awards of the ICC and the Lex Mercatoria, GP 2001, legal writing, April 29), from a total of 1228 awards, fewer than approximately thirty, that is 2.5% of the total, expressly mention lex mercatoria as the legal rule applicable to the contract and in the great majority of those cases decided, the parties do not mention that source. Further, from analyzing 9 awards it follows that lex mercatoria does not offer any originality by reference to the general contract principles of the national systems involved in those published cases. Indeed:

- three of those awards do not dwell on the rule coming from the lex mercatoria involved;

- two others apply the rule to good faith, which could also be found in other competing legal systems;

- another one decides the cases on the basis of a mediation clause;

- another still acknowledges the existence of general principles of contract law, without giving more details as to content;

- finally, another refers to good faith as a general legal principle that must be considered as a principle common to all national legal systems, otherwise said to belong to lex mercatoria.

Further, the relationship of lex mercatoria with the Unidroit Principles has been acknowledged in an award that, resorting to lex mercatoria as the applicable law, has determined that it is possible to “refer, for issues pertaining to the general regulation of contracts, to Unidroit principles related to international commercial contracts, which represent -except for some very specific rules (e.g. articles concerning hardship: see ICC award N0. 8873 of 1998, Journal de Droit International, 1998. 1017)- a faithful “restatement” of the rules that enterprises engaged in international commerce consider in harmony with their interests and expectations” (ICC award N0. 10422, from 2001: JDI 2003. 1142 comment, E. Jolivet).

This proximity between these two contractual systems could explain why, for the moment, the Unidroit principles are rarely chosen, fewer than twice for each one thousand cases according to an estimate (V. Heuzé, Concerning a European initiative in the law of contracts, University of Paris I study), confirmed (F. Marrilla and F. Gélinas: Bull. Cour CCI 1999, vol. 10/2 and 12/2, chronicling a great part of ICC awards that mention or apply the principles). But it has also been shown that the use of such Principles was uncertain (C. Seraglini, On the good use of Unidroit Principles in International Arbitration, Revue de l’Arbitrage, 2003, p/ 1101).

Should one infer from this that the practical needs are already satisfied and a unified system on contractual law is not required?

IV. What are the choices?

IV-1. Shared rules. All the proposed rules, whether about international contracts or about European contracts are based on two fundamental principles of contract law: contractual freedom and the binding power of contracts (pacta sunt servanda). At a time when a market economy prevails practically the world over one can’t conceive these two tenets being challenged when they have such a strong historical and present justification.

Also unanimously accepted is the corollary to contractual freedom: the limitation marked by public policy. It is universally evident that under certain circumstances contracts are protected from their own weakness and that general interest justifies imposing certain restraints on them.

By a similar reasoning that contractual justice requires that contracts must be performed in good faith. Of course, one has heard very often that the common law does not know the principle of contractual good faith. But what common law are we talking about? A study published in France (Ph. Pinsolle, Distinction between the principle of estoppel and the principle of good faith in international Business Law, Journal du Droit International 1998.905 and fol.) has shown that regardless of the position that estoppel is not an application of the principle of good faith, estoppel allows, at least in the United Kingdom, to sanction bad faith and, further, particularly in Australia and in the USA, to make one’s good faith prevail. The commentaries of Prof. Lando’s Commission (I. De Lamberterie, G. Rouhette dt D. Tallon, Principles of European Contract Law, French Documentation, Paris, 1997, p. 54) underline also that “numerous results that are achieved through the use of good faith, are attained in the English and Irish systems through specific rules”.

IV-2. Mandatory rules. The development of contractual law rests on an adequate system of obligations that stem from it. Techniques such as compensation, subrogation, assignment of rights, delegation of duties, novation, are also indispensable for exchanges that facilitate the financing of contracts, the insurance of the risks they create and their circulation. Just as the Paulian action sanctions the fraud against creditors, the oblique action allows creditors to recover the assets that their debtor neglects to claim from third parties and the action to recover a payment that was not due are indispensable to protect credit, which is the irreplaceable engine of economic development.

In all these areas, according to the observation of the famous French jurist Carbonnier, the Romans have been the definite inventors of the Euclidian geometry of contracts. This means there is no spectacular event that we can expect from the present movement for reform which, besides, remains silent of this topic.

IV-3 Different rules. Three new sources, contemplated above (III-1) are not recognized by all national legal systems and deserve some consideration: lesion, reformation and unilateral termination.

IV-3-1. Lesion. Systems inspired by the French Civil Code of 1804 have been reluctant to annul or to readjust a contract because of a gross disproportion between each parties’ obligations. Legislators of the end of the XXth century, following the example of the German Civil Code of the end of the XIXth century and of the Swiss Federal Code of Obligations of the last century, have, however, sanctioned the notion of lesion. This can be seen in the Dutch, Brazilian and Quebec codes, as well as in the Unidroit Principles, the Principles of European Contract Law and the European Contrct Code. But resistance to the concept of lesion continues, even in the most recent works on modernization, such as those undertaken in Louisiana and in Argentina.

But this divorce is more apparent than it is real. There are four decisions from the German Federal Supreme Court (BGH) revealing an application of this text that addresses situations which French law also fights against:

- a decision of BGH, of 1/12/96 concerning lesion in the sale of real estate where it is expressly admitted in French law for the seller’s benefit (Civ. C., art. 1674);

- a decision of BGH, of 12/6/90 concerning a guarantee that is out of proportion with the debt it protects, which French law sanctions as a mistake committed by the guarantor or through the judge-made rule requesting that the guarantee must be proportionate to the guarantor’s income.

- the decisions of BGH, of 5/8/02 and of 9/11/02 relate to the overvaluation by the seller of an on-going business, which French law contemplates through specific rules

One should add the corrections that allow vices of consent (fraud, mistake, violence) and the requirement of good faith.

As a matter of legislative policy it should be decided if it is better to enact a general text or to have a bigger number of corrective rules applying to different sets of cases. The first approach is more in keeping with the readability of a system that is more in harmony with the the coherence of its rules. The second approach is more suited to the initial thoughts of the parties and to contractual justice since it allows to sanction disproportions that are repugnant to the idea of justice. Law professors of continental Europe would certainly prefer the first approach. As it is reflected in the three drafts that are, practically exclusively, the work of university professors. Practicing attorneys might be more prone to choose the second possibility. But one awaits their input in the three drafts, but professors seem in no haste to hear such contributions.

IV-3-2. Reformation. In practice, systems that accept lesion and the European drafts, also accept reformation of the contract for change of circumstances and vice versa, except for the code of Quebec which adopted lesion but not reformation.

This situation might cause surprise when one learns how it works out in practice. Indeed, on the one hand, according to a distinguished French comparatist (R. David, cf. Work of the French Committee on Conflict of Laws, 1988 - 1990 p. 164) the foreign systems that have accepted reformation, are applied with great moderation by those courts. On the other hand, international commercial arbitrators refuse reformation when the parties haven’t specifically foreseen it (sentence n° 1512 en 1971 : Journal du droit international 1974.905 ; sentence n° 1990 en 1972 : Journal du droit international 1974.897 ; sentence n° 2216 en 1974 : Journal du droit international 1975.917 ; sentence n° 2404 en 1975 : Journal du droit international 1976.995 ; sentence n° 2508 en 1976 : Journal du droit international 1977.939 ; sentence n° 2708 en 1976 : Journal du droit international 1977.943 ; sentence CCI n^o 8486 en 1996, Journal du droit international 1998.1047 obs. Y. Derains ; sentence CCI n° 8873 en 1997 : Journal du droit international 1998.1017 obs. Derains).

Arbitrators often base their decisions on a presumption of knowledge by those professionals of international trade who, due to their experience, are supposed to have waived reformation of the contract by the fact of not including it specifically. Alternatively, they base their decisions on the naturally speculative character of international transactions. An award has even shown that the Unidroit Principles were not, on this point, in agreement with the expectations of enterprises (sentence CCI n^o 10422 en 2001 : Journal du droit international I 2003.1142 obs. E. Jolivet). It is not different if the arbitrator decides the case as a mediator (Cass. civ. 28-4-1987 : Bull. civ. I p. 96).

IV-3-3. Unilateral termination. According to the Unidroit Principles and to the Principles of European Contract Law, a party to a contract may terminate it by giving notice to the counter party. That choice has been inspired by the Danish law of sales, the common law, the Portuguese and German Civil Codes and the Vienna Convention for the International Sale of Goods. This is contradicted by the Belge, Spanish, French or Italian solution, which force the juge to issue a decision.

Giving notice is not, of course, a discretionary power. The sender can only opt for this solution when facing the other party’s substantial nonperformance. This condition, present in the Principles of European Contract Law is practically retaken by the other systems that accept unilateral termination. It raises the question of how effective it really is, because what happens if the other side challenges such termination? In a state of law nobody can make justice with his own hand and resorting to the judge to end the conflict is unavoidable. But must the judge order the continuation of the contract if he deems the condition not met, or must he consider the contract untouched by the notice, or should the judge consider the contract irretrievably terminated by the notice and award damages to the side affected by an unjustified termination? In the first case, the differences are erased by systems that only allow the court to decide the contract’s fate. For the second group the difference is real because the party giving notice is allowed to decide what happens to the contract, regardless of the price that decision may cost him. But is this the rule applied by judges having to decide issues of unilateral termination? To the extent of my knowledge, it seems unlikely: lacking a sound understanding of German decisional law, we can’t say which is the effective solution applied in Germany. However, we have found an arbitral award deciding that a simple delay in payment by the purchaser does not justify the immediate termination of the contract but rather the granting by the seller of a supplemental term, by application of the Vienna Convention, article 63, not being in presence of a substantial violation of the contract (sentence CCI en 1994 n° 7585, Journal du droit international1995.1015) and a decision in the same sense in (Dalloz 1999.som.359 obs. J. Niessen).

Conclusion

3. We believe that, in the present sate of development of European drafts, it is essencial to research if these drafts are indispensable for a real improvement of the European Community domestic market, and to verify that they cater to the needs of the economic operators.

Should these two questions receive an affirmative answer, the drafts must be enacted. If the reply were negative, the drafts would be due more to dogmatic trends than to the desire to improve the economy which, however, is used as a justification.

Above all, since you are practitioners in the field of contracts, the definite conclusion rests with you.