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6.1 Why Negotiate and Draft a Contract?

In domestic business relationships it is common for parties, when entering into a contractual relationship, not to discuss the legal aspects of their agreement, but to limit themselves to negotiating the basic contents of their deal. For example, in the case of a regular sale in a shop, the parties will agree upon the goods purchased and their price, and will take immediate delivery of the goods without discussing the legal obligations arising out of the deal. If any problem arises later (e.g. if the goods prove to be defective), the solution will be found in the rules of the applicable law governing the contract in question.

However, when contracts are more complicated or involve greater amounts of money, including most contracts between businessmen, parties will normally prefer to establish their own rules, to expressly define what their respective obligations are under the contract, while remaining within the framework of the applicable rules of law, which may, in various ways, limit their freedom (party autonomy), especially by dictating mandatory rules that the parties must, in any case, observe.

Where the law provides specific rules for a given contract such as a contract of sale, in principle the parties will only need to draft their own rules when the standard solutions provided by the law do not conform to their needs or do not answer issues they need to clarify.¹ However, many contracts currently used — for example: distributorship, franchising, patent licence, trademark licence and transfer of technology — are not regulated by the law in most legal systems. Where this is the case, there is an additional reason for drafting detailed contracts: namely, to establish precise rules on the main issues of the contract in question.

When we shift from domestic to international contracts, the need for establishing specific contractual rules increases substantially because cross-border contracts are placed in a far less certain and foreseeable legal framework. If the parties have not made a clear choice of the applicable law, it may be difficult to determine in advance which law will govern the contract and, consequently, which rules will govern the obligations of the parties not expressly covered by the provisions of the contract.

6.1.1 The trend towards self-sufficient contracts

Although parties should decide under which law the contract will be placed before drafting and negotiating a contract, it is not always possible to follow this practice.

Contracts are often drafted and negotiated before the applicable law has been chosen, because many negotiators consider this to be of secondary importance.

Moreover, parties frequently work out standard contracts for use in several potential future situations and in the (possible) context of different national laws, which implies that they cannot be construed in compliance with a specific domestic law.

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Finally, many types of contracts frequently used in cross-border trade are not “codified” in domestic laws; consequently the drafters tend to cover the greatest possible number of issues in the contract itself. Many of these contracts (e.g. licensing agreements, distribution contracts, M&A agreements and turnkey contracts) circulate across national borders, and the standard clauses they contain tend to impose themselves in contractual practice, independently of the national law that will actually govern them.

This scenario explains why cross-border contracts tend to be drafted, as far as possible, as self-sufficient documents that are becoming more and more independent from specific domestic laws. In other words, contracts used in international trade are tending to become increasingly similar and less closely linked to a given domestic legal system.

It should be clearly stated, however, that the idea of a self-sufficient contract which can “stand up” under any legal system is an impossible and illusory goal. Due to the variety of rules of the different legal systems, it is impossible to draft a contract that complies with all of them.

However, at the same time, it is possible to reduce the risk of conflict with the applicable rules of law by both drafting contracts that are as detailed and exhaustive as possible,² and by choosing applicable rules of law from legal systems which have few mandatory rules or which have mandatory rules that conform to the expectations of international traders.³

Therefore, it is very useful to devise contracts that are as self-sufficient as possible, bearing in mind that, whenever possible, one should check their compliance with the rules of the applicable law in advance.⁴

This trend towards self-sufficient and complete contracts, which has also been influenced by common law lawyers who tend to use this approach in their domestic deals, is a positive one, provided that the drafting technique is applied in a reasonable way and without excess. It is important that a contract cover all important issues, but this does not justify the technique of “inflating” contracts by adding unnecessary clauses or by complicating matters that can be kept simple.

For inexperienced parties, there is a danger that lawyers, instead of helping them by “streamlining” the various issues and construing a coherent and well-organized set of rules, may introduce unnecessary complications that do not answer the parties’ actual needs. This risk has become greater now that, due to the wide circulation of contracts in digital form, it is extremely easy to copy clauses from existing models.

Of course, when parties say that the contract must be short and simple, they underestimate the fact that this contradicts the need for completeness. A contract cannot be short and exhaustive at the same time. On the other hand, there should always be a fair compromise between completeness and reasonable length when deciding which issues a contract must cover.

If there is a close cooperation between the lawyer who drafts the contract and the businessman who signs it — because the two decide together which issues are relevant and which are not — the above risk will be significantly reduced.

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6.1.2 Oral and written contracts

Many non-lawyers fail to understand the difference between an agreement by which the parties undertake certain obligations towards each other, and the written document, signed by the parties, which contains the terms of such agreement.

Business people are therefore often convinced that only the written agreement signed by them is a binding contract and that whatever they agree orally does not bind them, as can be seen in the following example.

This is a rather extreme example, since it presupposes that a businessman is unaware that a contractual relationship can come into being without a written agreement (although this situation is far less exceptional in practice than one would imagine).

A more realistic example would be a case in which a manufacturer entertains a continuing relationship with an importer who purchases and resells his products in a given country. In this case, it may not be clear if the importer is effectively a mere customer or if he should be considered to be a distributor, protected by the rules that may be applicable in his country to this contract.⁵

If there is no closer relationship, there are no problems. But where the continuing relationship with the importer would be qualified under the law of the distributor’s country as a distributorship contract, the fact of not having put such agreement in writing may entail considerable disadvantages for the exporter, as shown in the following example.

In this case, it would have been better to conclude a written contract, in which the parties could have agreed upon a reasonable notice period (the duration of which would, in principle, be recognized by the courts, while in the absence of such indication it is more difficult to determine what the correct notice period should be), and where other useful clauses could have been inserted, such as an arbitration or choice of forum clause.

All of this demonstrates that relying on oral agreements is dangerous. Whenever parties enter into relationships that could give rise to future problems, they should establish a written contract and specify all relevant issues in that context. This is not only useful for the purpose of clearly establishing the contents of their agreement, but may also be a device for checking whether all relevant issues have been considered.

6.1.3 Letters of intent and similar documents

A rather common practice in international trade, particularly in the context of complex dealings, is to sign documents that leave some ambiguity as to their binding character. These are presented under various names: letter of intent (LOI), memorandum of understanding (MOU), heads of agreement.

It should be said from the outset that in many cases the ambiguity is due to the more or less intentional desire of one party to bind the other party, without being bound itself. It has been rightly said that:⁶

… obscurities and ambiguities are not totally unintentional. […] Each party, in other words, seems to be preoccupied by the concern of binding the other party not to re-discuss the points of agreement recorded in the letter of intent, while at the same time preserving for itself the freedom to re-discuss said points. Thus, perhaps not always at a conscious level, each party appears to show a tendency to consider a letter of intent as binding only for the other party.

It is impossible to determine the binding character of this type of document in general terms. This will depend very much upon the wording of the agreement and the applicable law.

Since a precise answer to these questions can only be given with respect to a particular case, and with reference to a specific legal system, I will limit myself to a general overview of some typical situations where the above problems arise.

6.1.3.1 Situations where letters of intent are used

The purpose of letters of intent varies substantially from case to case. It may be helpful to examine some typical situations frequently encountered in international trade.

First, there are a number of situations in which the non-binding nature of the document should be beyond dispute. This is the case, for example, when the negotiators simply wish to confirm their reciprocal interest in negotiating the contract, mainly because they need to show the party they represent that there are good reasons to continue such negotiation. Alternatively, a party may wish to obtain — in the course of negotiation — a non-binding declaration of interest from the other party, [Page114:]because it hopes that this might put the other party under moral pressure if it changes its mind. In this type of case, there should be little doubt about the non-binding nature of the document, although no certain conclusion can be drawn without considering the specific wording of the letter of intent and the applicable rules of law.

A less clear situation arises when the parties sign a document in which they sum up the results reached at a certain stage of the negotiations, distinguishing the issues agreed upon from those still to be negotiated. Agreements of this type may imply an understanding not to bring up for discussion the issues already agreed upon⁷ and, more generally, an obligation to conduct further negotiations in good faith.⁸ In fact, agreements of this kind may cause more confusion than create advantages for the parties, considering the difficulty of assessing which behaviour conforms to good faith and which does not.

Another common situation arises in the context of contracts that are necessarily negotiated and concluded through subsequent steps.

If one considers an M&A contract for the acquisition of the shares of a company, normally the parties will sign a letter of intent when they have agreed on the basic aspects of the transaction and will postpone the conclusion of the agreement until a number of further steps have been taken.

A similar situation arises when the parties agree to establish a cooperation project involving the creation of a jointly owned company (joint venture). Here, the parties first need to agree upon the overall scheme and thereafter work out the details of the operation, which implies the creation of one or more companies, the drafting of contracts between the mother companies and the joint venture, obtaining government authorizations when necessary, etc.

In cases of this kind, the letter of intent or memorandum of understanding will normally be much more than a simple declaration of intent: it will be an agreement on the essential terms, which leaves open for further determination the terms that could not be defined at this stage.

Situations of this kind are very difficult to classify from a legal point of view.

In some jurisdictions, particularly those that do not accept the idea of an “agreement to agree”, the letter of intent will have little or no value; in others, it may give rise to a duty by the parties to continue and conclude in good faith the negotiation on the issues left open.

The above case shows how uncertain the solutions can be with respect to agreements that refer certain issues to further negotiation. Parties should, where possible, know in advance which legal system governs their agreement and make clear if and to what extent their agreement is effective under the applicable law. When this is not possible, arbitration will normally be the most appropriate solution in case of a dispute.¹⁰

In some jurisdictions, a letter of intent or memorandum of understanding leaving a number of issues open for further negotiation may be considered a binding contract, the details of which can be filled in by the competent courts on the request of one of the parties.

An interesting case, decided by an ICC arbitral tribunal in 1996,¹¹ is described in the following example.

In the above case, the arbitral tribunal awarded damages to the Iranian party for the loss of the ability to enjoy the probable benefits of the two aborted projects.

6.1.3.2 Advice to negotiators

As shown in the above examples, it can be difficult to foresee the actual value of letters of intent and similar documents, since this depends on the specific wording and, most of all, on the rules of the applicable law, which vary substantially from country to country.

The problem is that in most cases the parties themselves wish to avoid clarity and to maintain a certain ambiguity with respect to the binding force of the document they are drafting.

Consequently, the first task of a negotiator is to understand what the party in question really wants. Does it want to be bound or not? Does it expect the other party to be bound or not?

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Once it is clear where the ambiguity lies, in principle it is possible to redraft the clauses to avoid any possible misunderstanding. Thus, the parties can explicitly state that certain promises are not legally binding and that the other party cannot rely on them. Or, on the contrary, they can expressly state that certain undertakings are legally binding in all respects.

This kind of exercise can be useful to ensure a better understanding of what the parties really want, but where ambiguity is necessary to reach an agreement (because its very purpose is to hide an actual disagreement), it may be necessary to accept the risk of unclear wording. If this is the case, because no other solution is possible, the negotiator should try to minimize the risk by drafting clauses that are as close as possible to the expectations of his party and should, at the same time, check the effect of the clauses under the applicable law. In any case, the negotiator must be aware that his party is taking a risk against which it should be protected, for example, by choosing a resolution of disputes mechanism that may put his party in the best possible situation in case of a dispute.

6.2 Preparing for the Negotiation of an International Contract

As noted in previous chapters of this book, international contracts, unlike domestic contracts, are negotiated in a far less predictable legal framework, in which a great number of issues (applicable law, jurisdiction) may vary substantially from case to case.

This situation has a considerable impact on the negotiation stage of a contract, since the parties will need to investigate a number of issues in order to identify the legal framework within which the contract will be situated and, where necessary, to change this framework according to their specific needs.

Of course, the decision of how to approach these problems depends upon the particularities of each case and the preferences of the negotiators, which makes it difficult to set out precise rules. I will try to describe here the various steps that are normally appropriate, which does not mean that they should always be followed, since such a decision will depend upon the complexity and the particular circumstances of each contract.

6.2.1 Identifying the legal framework where the contract is to be situated

A first step to be taken is to identify, at least in general terms, the legal framework where the contract is to be situated, which will also determine the choice of applicable law.

The steps normally to be followed in this stage are the following:

1. First, one should identify the rules that govern the type of contract in question within the potentially applicable legal systems (normally those of the countries of the parties),¹² in order to verify if these rules conform to the expectations of those drafting the contract and whether there are mandatory rules that cannot be derogated contractually.
2. It may also be appropriate to verify if there are other rules, such as currency regulations, antitrust rules, prescriptions regarding the products (with respect to security, labelling, rules on reservation of title, etc.), that may affect the contract in the legal systems at issue. Of course, it is impossible to say a priori which issues should be considered, since this depends on the subject matter of each contract and the specific needs of the parties.
3. The result of this inquiry should put the negotiator in a position to make a first assessment about the acceptability of the laws of the countries involved as possible governing laws of the contract. Of course, the choice of the applicable law will also depend on other considerations,¹³ but knowing what the impact of the possible alternatives is will certainly provide the negotiator with important elements for making a responsible choice.[Page117:]
4. After having identified which law can be considered in the first instance as the most suitable with respect to the needs of the negotiator, one should verify to what extent the choice envisaged would actually be recognized and effective in the interested countries. ¹⁴

A problem not to be underestimated is the difficulty of obtaining information about foreign legal systems, especially those in certain countries. In recent years this issue has become less critical, because the laws of a great number of countries can be found on the Internet, but it should be considered that this will normally not be sufficient in the absence of information about the actual interpretation and implementation of such rules. Where it appears impossible to know the contents of the foreign law, negotiators should approach the problem realistically and look for alternative solutions, such as the choice of a neutral law and a satisfactory solution for the resolution of possible disputes, even where these may imply some risks.

6.2.2 Establishing a draft in view of the negotiation

While identifying the legal framework in which the contract is to be placed, the parties will normally begin to draw up the terms of the contract in order to have a draft to submit to the other party.

6.2.2.1 The use of standard clauses or models

For those who draft international contracts, models are an essential tool for identifying the key issues of the contract in question and for obtaining useful hints about the possible solutions to consider. Since model contracts are normally the result of a comparison between several individual contracts, they generally offer a comprehensive view of the main issues of a particular type of contract and the respective solutions already vested in contractual clauses.

While a good model is an essential basis for drafting an individual contract, it may become a dangerous tool if used “as such”, without adapting it to the specific circumstances of the case.

Parties should, whenever possible, draft their contracts with the assistance of a lawyer, who will have the responsibility of adapting the clauses to their specific needs and making sure that the solutions chosen are lawful and effective.

This being said, it is common knowledge that many traders prefer drafting contracts by themselves, without the assistance of a lawyer, on the basis of the materials they are able to find.¹⁵ This tendency should be opposed by making the users aware of the dangers that arise when drafting international contracts without the advice of an expert. However, whatever attempts are made in this direction, the fact remains that many businessmen continue (and will continue) to negotiate and draft international contracts without any legal assistance. It follows that if this is the real-life situation, there is a clear need for good model contracts that can at least reduce the risk of bad drafting.¹⁶

This is why ICC decided to prepare standard forms, which are not only intended to serve as a “model” for the lawyer who needs to draft a tailor-made agreement, but which can also be used as such by a businessman, together with a number of devices intended to reduce the risk of inappropriate manipulation of the contract text. This issue will be discussed later in § 7.1.2.3.

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Another problem, which arises as a consequence of the growing availability of easy-to-copy model forms (especially after the introduction of personal computers and the Internet), is the possible abuse of standard forms, including by lawyers.

Since it has become so easy to obtain hundreds of well-drafted clauses, many drafters cannot resist the temptation to use this wealth of material in order to draw up extremely ponderous and comprehensive contracts, at the risk of forgetting the actual needs of the party involved. Moreover, the technique of mixing clauses of different origin may cause the drafter to lose control over the contract as a whole and give rise to inconsistencies or insufficient coordination between the various clauses.

Another risk is that the negotiator may feel bound to the pre-established clauses because he does not want to take the responsibility of adapting them to the circumstances of the case, and may consequently refuse the requests of his client to look for alternative solutions that would better comply with his needs.

All of this means that model contracts and standard clauses must be used in the right way. They are certainly essential tools for preparing a good contract, but the negotiator must be able to use them appropriately without losing the necessary creativity for setting up a contract that truly matches the specific needs of the parties.

6.2.2.2 Identifying the most appropriate solutions and negotiation margins

While identifying the critical issues of the contract, the lawyer must determine, in close cooperation with his client, the contractual solutions most appropriate in the specific case.

This is a very delicate stage, where a close cooperation between the lawyer and the businessman is needed, since almost all issues to be decided involve economic and commercial choices which affect the allocation of risks and charges between the parties, but which may have legal implications. This is because a certain solution may be unlawful and another not, or because one solution may be more or less onerous.

This means that a reasonable compromise must be found between the business needs of the party on the one hand and the legal requirements on the other. The lawyer must understand the needs of the businessman and look for solutions which can answer such needs without breaching the law, but the latter must accept that not all of the solutions he would prefer are legally acceptable.

In this context, the lawyer will try to work out reasonably unambiguous clauses, knowing that the agreement whose contractual provisions are too vague often hides a substantial disagreement, which may create problems during the performance of the contract. But here too, a certain degree of flexibility is required, because a too rigid attitude on this subject matter may cause difficulties in negotiation. In other words, a certain degree of ambiguity may be unavoidable, and a good lawyer should try to find the right balance in order to reach a compromise solution with the least possible risk.

Finally, a very useful exercise during this preparation stage consists in working out alternative solutions on those issues where it is likely that the other party will not accept the proposed clauses. This is not only because it is important to have alternatives to propose in the course of the negotiation, but also because it is important to know in advance what the disadvantages are in terms of costs, risks, etc., of the various solutions.

6.3 The Negotiation Stage

Except in circumstances where a party is forced to accept the contract without discussion — a situation that frequently arises where the bargaining power of the parties is very unbalanced — the contract will normally be a compromise between the opposing positions of the parties, which is not always easy to reach. Depending on the complexity of the issues in question, the respective needs of the parties and the distance between their expectations, the negotiation can last a few hours or several months.

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6.3.1 The approach to negotiation

The negotiation of a contract implies by its very nature that the parties will discuss their respective positions and look for compromise solutions that reflect their respective bargaining power.

However, it is not only the bargaining power that counts. The ability of the negotiator can also play an important role. It is therefore wrong to assume, as many small companies do, that negotiating with a stronger party is useless because the latter’s requests will have to be accepted in any case. Of course, there are situations where there is almost no room for discussion (e.g. where a very big company asks for the application of its general conditions of purchase), but in many other cases the stronger party makes proposals which it is open to discuss, and it would be wrong to accept them before having at least tried to modify them.

Moreover, small companies often see themselves as weaker than they actually appear to be in the eyes of their counterpart.

Finally, it can never be excluded that reasonable requests, when they are explained and presented in the right way, may be considered seriously by the other party, particularly in the context of long-term contracts where it is important to create a good spirit of cooperation and to maintain it during the life of the contract.

An important tool for strengthening the bargaining position of a party is to base the discussion on a draft worked out by that party and to continue the negotiation using the same document, thus giving the negotiator the advantage of discussing within a familiar context.¹⁷

6.3.2 The ICC Principles to facilitate commercial negotiation

The ICC Commission on Commercial Law and Practice (CLP Commission) has prepared a set of Principles to Facilitate Commercial Negotiation, directed at small, medium or large businesses across many sectors, which are intended to help negotiators conduct smooth and efficient commercial negotiations, which can be downloaded from the ICC website, www.iccwbo.org.

The Principles are based on the idea that the best deals are struck between negotiating partners that not only want or need to collaborate, but also respect and trust one another. They provide the direction for creating or enhancing a productive working relationship, for transactions of any size or length.

The Principles cover a variety of issues: preparing the negotiation, taking into account cultural differences between the parties, agreeing timely about the negotiation process, acting with transparency and integrity, making realistic commitments.

The ICC Principles to Facilitate Commercial Negotiation can be a useful tool for preparing to negotiation and also for convincing the other party to follow the same reasonable and transparent approach.

6.3.3 The role of the lawyer in the course of negotiation

We have already noted (§ 6.2.2.2) the importance of a close cooperation between the lawyer and the manager in preparing a draft contract. The same need for a joint approach exists during the negotiation stage, where the businessman needs to know from his lawyer if the alternative solutions discussed with his counterpart are legally feasible and, if not, what other solutions can be found.

It is therefore important that the lawyer be involved in the negotiation from the very beginning and that he actually knows the strengths and weaknesses of the deal his client is negotiating, so he can understand the importance of the issues in discussion.

The practice of involving the lawyer at the very end and asking him to give his advice on a contract that has already been negotiated is unacceptable. The lawyer involved at the end of the process will only be able to give some advice concerning a number of[Page120:]strictly legal clauses — such as the choice of law clause or the arbitration clause — but he will be unable to judge from a legal point of view whether the best possible solutions have been found for the other issues. This is because he does not know their context. If the lawyer does not know which type of risk the parties were expecting to cover with a given clause, he cannot say whether the clause is effective and to what extent.

This is why the lawyer should be involved in the negotiation of complex deals during the whole negotiation stage. Of course, his participation will be effective only if he is able and willing to understand the business needs of his client,¹⁸and provided that he has the creativity needed to work out alternative solutions that may help overcome possible deadlocks.

This does not mean that the businessman must always be accompanied by his lawyer. In less important deals, where the participation of the lawyer at this stage would be too onerous, the non-lawyer will negotiate the contract prepared in advance with his lawyer and possibly wait to approve the final text after having verified the modifications with him. This is particularly the case when the lawyer has worked out a standard form with the client to be used in several circumstances, a typical situation with respect to agency or distribution agreements. Here the lawyer will mainly be involved in order to check if there are special problems with respect to the legal system of the other party, and to verify, if possible, whether modifications required by the counterpart are acceptable.

6.3.4 The recourse to local lawyers

Where there are no particular problems concerning the application of a foreign law (e.g. because the interested party is able to negotiate that the contract will be governed by its own law), there will normally be no need for involving foreign lawyers in the negotiation.

Where, on the contrary, the contract is to be governed by a law not known by the lawyer responsible for the drafting, this should, in principle, require the assistance of a lawyer from the country whose law is to be applied. This is in order to verify whether the solutions negotiated are fully valid and effective under such law.

However, it must be noted from the outset that such a solution is more difficult than one might think. In fact, in many cases the foreign lawyer will not understand the drafter/negotiator’s point of view of and will consequently be unable to give the right advice. There are several reasons for this. First, lawyers tend to reason within the framework of their own legal system and have difficulty in understanding questions that arise in a different context. Second, a lawyer who has not been closely involved in the negotiation and is not familiar with the underlying problems will be unable to identify the real legal issues and to work out alternatives that will provide a solution to the problems raised.

This does not mean that one should not request the advice of local lawyers, but rather that such advice will only be fully effective if the foreign lawyer has the necessary legal background — which mainly means the practice of assisting foreign companies — and if he can be closely involved in the negotiation so that he can appreciate the reasons why the legal issue on which he is being asked to give advice is important for the contract in question.

If, on the contrary, the lawyer is simply asked to answer a purely legal question, which is not placed in the actual context of the negotiation, it is likely that his advice will be of little use, except that the negotiators may discharge their responsibility if something goes wrong.

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6.3.5 Responsibility of the parties during negotiation

An important issue which arises when negotiations fail is that of determining if and to what extent the parties must respect certain obligations, even in the period before conclusion of the contract.

The approach to this problem varies substantially from one legal system to another.

Most civil law countries adopt the principle that during negotiations the parties must act in good faith, which means in particular that a party that interrupts negotiations in bad faith (e.g. after having given its counterpart a reasonable expectation that it would conclude the contract), or that carries out parallel negotiations without informing the other party, may be liable for damages. The precise conditions for such “pre-contractual liability” are not the same in all countries. Furthermore, as regards the recoverable damages, some legal systems limit the compensation to the so-called negative interest (i.e. the expenses sustained for the negotiation) while others also include the loss of profit or loss of a chance.

Common law countries tend to follow a more restrictive approach. In English law, for example, a traditional view seems to prevail whereby the parties have no obligations as to the conduct of the negotiation and are free to interrupt it and/or to carry out parallel negotiations with third parties until the contract is concluded.¹⁹ This practice, however, has been substantially mitigated in recent times.

Considering these differences, it is impossible to determine the extent of the parties’ liability during the negotiation stage without analyzing the legal system applicable in a specific case.

An attempt to set out uniform rules adapted to the needs of international trade has been made in the UNIDROIT Principles, which mainly follow the civil law approach, by stating the following rules:

UNIDROIT Principles – Article 2.1.15 – Negotiations in bad faith

1. A party is free to negotiate and is not liable for failure to reach an agreement.
2. However, a party who negotiates or breaks off negotiations in bad faith is liable for the losses caused to the other party.
3. It is bad faith, in particular, for a party to enter into or continue negotiations when intending not to reach an agreement with the other party.

This provision, after having stated in the first paragraph the general principle of freedom of negotiation, provides in the following paragraph that such freedom is not unlimited, but must be coordinated with the obligation to negotiate in good faith.²⁰ As to the actual meaning of good faith in this context, the official commentary to Article 2.1.15 says that:

A party’s right freely to enter into negotiations and to decide on the terms to be negotiated is, however, not unlimited, and must not conflict with the principle of good faith and fair dealing laid down in Article 1.7. One particular instance of negotiating in bad faith which is expressly indicated in Paragraph (3) of this Article is that where a party enters into negotiations or continues to negotiate without any intention of concluding an agreement with the other party. Other instances occur when one party has deliberately or by negligence misled the other party as to the nature or terms of the proposed contract, either by mispresenting facts, or by not disclosing facts which, given the nature of the parties and/or the contract, should have been disclosed.

Another article of the UNIDROIT Principles provides that parties who negotiate a contract are bound to respect a duty of confidentiality.

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UNIDROIT Principles – Article 2.1.16 - Duty of confidentiality

Where information is given as confidential by one party in the course of negotiations, the other party is under a duty not to disclose that information or to use it improperly for its own purposes, whether or not a contract is subsequently concluded. Where appropriate, the remedy for breach of that duty may include compensation based on the benefit received by the other party.

The above provisions can be very useful for arbitrators, in cases where they decide to apply these rules instead of domestic rules to a dispute involving pre-contractual liability. However, it should be noted that where the UNIDROIT Principles are incorporated by reference into the contract the parties have been negotiating (but have not managed to conclude), the rules on pre-contractual liability contained in the Principles should in theory not be applicable (since they are part of the contract that has not been concluded) unless the parties have agreed in advance that the Principles will govern all of their future deals.

6.3.6 Agreeing upon special rules for negotiation

In some cases, particularly when they are engaging in negotiations of substantial importance, the parties may agree in advance on the rules that are to govern the conduct of the negotiations.

The main issues to be considered in this context are the obligation to keep the information received confidential and the obligation not to deal with other parties.

6.3.6.1 Confidentiality agreements

A rather common practice is that of agreeing, before starting negotiations, that the parties shall maintain confidential — and shall use only for the purpose of the negotiation — all of the information received from the other party in the context of the negotiation.

This is especially the case when contracts are negotiated that imply by their very nature that the parties are exchanging confidential information, such as contracts for the acquisition of a company (where the purchaser must necessarily obtain the information necessary for evaluating the convenience of the deal and for determining the price), or transfer of technology agreements and know-how licences (where the licensee cannot assess the suitability of the deal he is negotiating without obtaining minimum information about the proposed technology necessary for the evaluation).

One of the key issues when drafting confidentiality agreements is to define what the confidential information is. If the definition is too broad, the agreement may unreasonably limit the freedom of the receiving party. At the same time, a too-narrow definition may substantially deprive the agreement of its usefulness.

Confidentiality agreements drafted unilaterally by the disclosing party are often unbalanced and may dangerously limit the freedom of the receiving party as regards the future use of information it already had before signing the agreement. This is why parties tend to exclude from the confidentiality obligation information that is already known to the receiving party or that is not confidential in nature, although this approach may leave room for uncertainty, which can benefit the receiving party.

A possible compromise is to require that the confidential information be expressly identified as confidential. However, in this case the receiving party must have the opportunity to object to the confidential character of information that it deems to be non-confidential.

Considering the above problems, parties should take great care in drafting confidentiality agreements. A useful tool to which they can have recourse is the ICC Model Confidentiality Agreement, ICC Publication No. 774, 2016 edition.

6.3.6.2 Undertaking not to deal with third parties and other clauses

Other possible clauses whereby the parties set up rules for future negotiations are those which limit their freedom to deal with other parties during the negotiation, or which provide for the reimbursement of certain expenses borne by one of the parties.

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For example, the parties may agree not to enter into negotiations with others during a certain period or grant each other a right of first refusal.

In special situations, where a party has to bear substantial costs during the negotiations, e.g. for carrying out specific projects or investigations in view of the future contract, a reimbursement of such expenses (or part of them) in case of failure to conclude the contract may be agreed on.

6.4 Drafting the Contract

Drafting contracts is a very demanding task that requires specific skills. Lawyers who draft contracts are in a certain sense, required to act as “legislators” of the parties, since the contract is “the law of the parties”. The lawyers must be able to “translate” the agreement of the parties into clauses that leave the least possible space for ambiguity and that are fully enforceable.

6.4.1 The trend towards common drafting standards

We have seen (supra, § 6.1.1) that there is a general trend in international trade towards exhaustive and self-sufficient contracts.

Drafting techniques and standard clauses tend to establish themselves across borders, which has led certain international contracts to become more and more similar to one another, independent of the national legal system that governs them. Thus, for instance, many M&A contracts and licensing agreements follow similar (mainly Anglo-American) drafting standards, whatever the applicable law chosen by the parties.²¹

This trend towards uniformity favours the establishment of a common practice in international trade that can make the negotiation of international contracts easier and more effective.

At the same time, however, many international contracts are still drawn up in accordance with the domestic standards of one of the parties. This will especially be the case when a stronger party prepares a draft under its own law and according to the techniques commonly used in its country. This approach cannot be criticized as such, since the parties are free to decide how they want to draft their contracts, and once a contract is submitted to a given national law it is fairly normal that it be drafted in accordance with the common usage of such country.

Nevertheless, the establishment of common contractual standards acceptable to traders the world over is certainly preferable, since it puts parties on an equal level and contributes to developing a sort of common language which makes communication and discussion easier between parties belonging to different legal systems. This is one of the reasons why ICC, when devising its model contracts, has tried, as far as possible, to set out clauses that are not linked to a particular legal system and that could become an international standard.

6.4.2 The basic requirements of a well-drafted contract

There are no absolute rules on how to draft a good contract, since this depends on the skill and experience of each individual. Nevertheless, it may be useful to state some general criteria that should be followed as much as possible.

First, the provisions of the contract should be clear and unambiguous for all those involved and not only for the parties who conclude it. When non-lawyers draft a contract, they often forget to mention issues that they take for granted, but which will not be at all obvious to a third party that may be called on in the future to decide a possible dispute. Consequently, a clause that may have a clear meaning when placed

[Page124:]

in the context known by the parties and discussed during the negotiations, may become ambiguous, if not quite incomprehensible, to a third party, or even to the parties themselves after a certain time.

It is therefore important that the clauses be drafted bearing in mind that they will be read by people not involved in the negotiation (judges, arbitrators), and that they resist a possible attempt by the lawyers to make them say the contrary of what the parties intended when concluding the agreement.

At the same time, contract clauses should be written in a way that the parties (and not only their lawyers) can understand their meaning. Of course, when the subject matter involves complicated legal issues, one cannot expect the wording to be simple, but this does not justify the bad habit of using unnecessarily complicated and obscure language when the same things can be stated plainly.

Another important requirement is that the contract follow a neat and coherent scheme. This will be helpful in situating the different issues within the agreement, especially if the contract is long and complicated. Even more importantly, it will help avoid contradictions between the various clauses. One should therefore remember that is not sufficient to put together a number of “good” clauses; on the contrary, it is essential to coordinate them within a coherent construction.

This means in particular that the lawyer who drafts the contract must have a clear idea of the agreement as a whole and thoroughly understand the links between the different issues involved. He must be able to adapt the various clauses to each other and maintain control over the global coherence of the agreement while negotiating amendments and modifications.

In absence of such a global understanding, the contract risks becoming a confused “pot pourri” of clauses contradicting each other, leaving wide room for disputes about their meaning.

6.4.3 Drafting techniques commonly used in international contracts

Some drafting techniques tend to be commonly used in international contracts, as well as in countries where they have been less known in the past. These include, among others, the inclusion in the contract of a preamble and the use of defined terms, mainly under the influence of common lawyers.

6.4.3.1 Inclusion of a preamble

A rather widespread use in international contracts is to put a preamble at the beginning of the contract.

The preamble will normally contain statements that do not set out the obligations of the parties — which should be placed in the contract itself — but that are nevertheless considered to be relevant by the parties, such as, for example, a description of the qualities of the parties, a certain factual situation existing at the time of conclusion of the contract or the reasons that have led the parties to conclude the contract.

For instance, the description of the circumstances that surround the conclusion of the contract and the context within which the contract is to be placed (especially when there are several connected contracts) may be important for the interpretation of its clauses when a dispute arises at a later stage, particularly when the other party tries to justify its interpretation through an untrue presentation of the facts.

Furthermore, the mention of certain facts in the preamble may also be useful in order to prevent the other party from denying them at a later stage.

It is not always easy to determine the legal value of the statements contained in the preamble, since this may substantially vary from case to case depending on the applicable law and other circumstances. Therefore, if the parties wish to make clear that they consider certain circumstances to be essential for the performance of their obligations, they would do better to include a clause in the contract setting out these circumstances as a condition for its effectiveness. [Page125:]As a general rule, when drafting the preamble, parties should ask themselves why they are making certain statements and verify if mentioning them in the preamble rather than in the contract itself is sufficient to obtain the result they wish to achieve.

6.4.3.2 Use of defined terms and capital letters

A common practice in international contracts is to define certain terms and then to use capital letters in order to identify the terms so defined.

This practice may be useful to avoid repeating long definitions in the various clauses. For instance, if the products that are the subject matter of the contract (and which may be listed in an Exhibit) are defined as “the Products”, the drafting of the clauses will be much simpler and the risk of using different wording for the same subject matter will be reduced.

Moreover, when the defined term refers to an issue that has to be specified in a particular contract — such as “products”, “territory” or names of the parties — it is easier to draw up standard contracts that can easily be adapted from case to case, simply by replacing the contents of the respective definitions.

In some cases, the parties list all the definitions at the beginning of the contract. This practice is certainly justified for complex and lengthy contracts, where certain terms are repeated several times. However, when this is not the case, it may be sufficient to define some basic terms that are to be frequently repeated in the contract when they are mentioned the first time, and to avoid “inflating” the contents through unnecessary lists of definitions.

6.4.4 The language of the contract

It frequently occurs in international contracts that the two parties do not speak the same language, and here the issue of language will inevitably arise.

There are several possible solutions: to write the contract in two languages, to use the language of one of the parties (normally the stronger one), or to use a neutral language (normally English) known by both parties.

The bilingual contract is certainly a balanced solution, but it requires a serious effort by the drafters, who must take care that the two versions truly correspond. In order to achieve this, it is not sufficient to have the contract translated by a third party, nor even by a translator specialized in legal matters. When the clauses are the outcome of a difficult compromise between the parties, the precise wording may be essential to their actual meaning. In some cases, only those who have written the clauses can ensure that the translation actually expresses what the parties had in mind.

Bilingual contracts are to be especially recommended for standard contracts, which can be prepared in advance. When the agreement needs to be translated immediately, during the course of the negotiation, it is normally preferable to draft it in a neutral language (normally English) known by both parties.

Sometimes one of the parties translates the contract in its own language and requests that such translation have the same value as the text written in the language used during negotiations. If this language is unknown to the other party and the exactness of the translation is difficult or impossible to verify, this may give rise to serious problems. One possibility is to refuse this request and to expressly state that the translation has no legal value. If this is unacceptable to the other party, a possible alternative solution may be to have the other party expressly warrant the exactness of the translation. In this case, the responsibility for possible differences would, in principle, be for the other party, and it would be difficult for the latter to invoke differences, since it guaranteed that the translation was accurate.

In any case, it should be remembered that, when a party knows or should know that the other party does not understand the language of the contract it is signing, the risk exists in some jurisdictions that the contract may be avoided on the ground of mistake. This is why parties increasingly tend to use a language known to both of them, normally English, which is becoming the current solution. [Page126:]

6.5 Clauses Frequently Used in International Contracts

There are a several clauses commonly used in international contracts that are becoming more and more similar.

The following paragraphs examine some of the most frequently used clauses and highlight their main characteristics, bearing in mind that clauses actually used by the parties vary from case to case and that their actual meaning and effectiveness may be influenced by the law governing the contract.

6.5.1 Force majeure

In international contracts, particularly those that are to last for longer periods, force majeure clauses, i.e. clauses dealing with the occurrence of unforeseeable events out of the parties’ control and their effects on performance, are very common.

6.5.1.1 Force majeure in various legal systems

The purpose of force majeure clauses is to draw a reasonable compromise between two contradictory needs: the right of a party to be exonerated from its obligations when their fulfilment is prevented by unforeseeable events for which it is not responsible, and the right of the other party to obtain the performance of the contract.

This issue is covered in most (if not all) national laws, but the positions taken in the various jurisdictions are not at all homogeneous. The same circumstances may exempt a party from responsibility in one legal system and not in another.²²

A certain trend to uniformity has been favoured by the Vienna Convention on International Sale of Goods (CISG), which expressly provides, in Article 79, a provision on force majeure, although not expressly mentioning this term).

Article 79 - CISG

A party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it, or its consequences.

A similar clause is contained in Article 7.1.7 of the UNIDROIT Principles, which reads as follows:

Article 7.1.7 - UNIDROIT Principles

Non-performance by a party is excused if that party proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.

In any case, the above is not sufficient, because in many cases the issue will be governed by the applicable (domestic) law, which makes it difficult to foresee what the result may be.

6.5.1.2 Force majeure in international arbitration

A consistent arbitral case law has developed with respect to force majeure. Although this case law is based on situations that are not always comparable — since the clauses themselves as well as the governing law of the contract vary from case to case — it deserves to be mentioned because it shows how arbitrators tend, notwithstanding these differences, to take a rather uniform attitude towards these problems.

The three conditions generally considered to be necessary for the existence of force majeure are:

1. the event must be unforeseeable;
2. it must be an event “outside the control of the parties”;[Page127:]
3. the event must make performance impossible or at least not reasonably sustainable.

Foreseeability of the event

As regards the first condition, in several cases force majeure has been denied because the event invoked was actually foreseeable.

An interesting case²³ concerns a charter contract of seven fishing vessels by a Russian party (“Owner”) to a Liberian company. The vessels had been mortgaged by the Owner as a guarantee for the repayment of loans. When the vessels were impounded by his creditors, the Owner invoked force majeure, but the arbitrators decided that the arrest of the vessels by the creditors was a foreseeable event (and also an avoidable event, of course, since the Owner could have paid his debt), by stating the following:

As unanimously recognized by the doctrine, as well as by the jurisprudence, including arbitration awards in international disputes, no matter whether in the frame of a civil law or a common law system, the essential elements of a “force majeure” situation are the unforeseeability and the irresistibility of the event. By the time the contract was signed, the seven chartered vessels were all mortgaged as a guarantee for loans apparently granted to the shipowner by a Russian bank […]. Therefore, a possible default by the shipowner, and the consequent possible impoundment of the mortgaged vessels by the creditor, were events easily foreseeable by the owner. They cannot be invoked as “force majeure” events.

It was the owner’s duty and responsibility under the contract to make sure that the charterer retains uninterrupted and free possession of the chartered vessels until the expiry of the agreed-upon term. It was also very likely possible for the owner to take in due time appropriate measures in order to avoid such events occurring. Therefore the element of “irresistibility” that should characterize a “force majeure” situation is also missing.

The requirement of unforeseeability has also been used for the purpose of excluding that a delay in delivery by a seller’s supplier could be invoked by the seller as force majeure. For example, in the case 3880/83²⁴a Belgian seller of boots invoked force majeure because of the delay by his Romanian supplier. However, the arbitrators denied the existence of force majeure, arguing that delay by a supplier was a foreseeable contingency.

In a case regarding a joint venture agreement,²⁵ which failed to attain its objective due to a situation of social unrest, the local partner (a State Entity) claimed the existence of force majeure in order to exclude its liability for not performing its obligations, but the sole arbitrator rejected such defence considering that the change in the social climate was foreseeable and the State partner should have taken it into account when agreeing on the joint venture.

In the present case, there is no clear evidence — and even no clear allegations — that the social climate had completely changed, in an unpredictable way, between the time of negotiations and the time of performance. It would have been the duty of the State Y partner to ensure that the regional social forces would not disturb performance of its contribution. […] In the present case, the non performance being almost total, it cannot be excluded that the organs of the State partner at the moment of concluding knew the difficulties and decided not to disclose them to ensure the performance of the foreign partner’s contribution before the latter noticed the difficulties. […] The existence of force majeure must be denied for the only reason that it has not been proven that the State partner could not foresee the circumstances that did not depend on it.²⁶

Event beyond the control of the parties

As regards the second condition, i.e. that the event must be “beyond the reasonable control of the parties”, problems frequently arise with respect to its practical[Page128:]application, particularly in cases where the force majeure event is an act of government (or of a public authority) of the country of the party invoking force majeure.

Although it would be excessive to say that acts by a government in the country of the party invoking force majeure cannot be considered force majeure because they are not beyond the control of such party,²⁷ there may be situations in which these events are not really outside the control of the party concerned, especially when there are close links between the party in question and its government. Where situations of this kind are likely to arise, the foreign party should try to negotiate a force majeure clause that excludes from the definition of force majeure acts of the government in the country of the party invoking the defence.

Irresistibility

This is probably the most difficult issue; since it would be excessive to limit the operation of force majeure to cases in which the performance is absolutely impossible. Therefore, it is necessary to decide what is reasonably impossible for a party.

For example, if a company agrees to ship iron across the ocean by sea and the vessel, which has been chartered in due time, is not available for reasons of force majeure − and no other vessels are available in time to respect the delivery date − it would be theoretically be possible to transport the iron by plane. However, if the cost of transporting iron by plane appears to be excessive, it is reasonable to claim that this alternative should not be considered reasonable and that the seller should be relieved from his obligations.

An interesting case,²⁸ which dealt with this matter in depth, concerned the construction of an airport in a country where an organization hostile to the government threatened, kidnapped and killed several employees of the foreign contractor. When the contractor decided to leave the work unfinished, invoking force majeure, the government objected that it was not impossible to complete the work, but the arbitrators decided as follows:

We do not think that when the Contract was concluded in December 1981 a reasonable business man in the position of the Contractor was entitled to assume, in the light of the known internal political, ethnic and economic problems of country X, that this job would be free from risk to those engaged upon it. Nor, in the situation prevailing in mid-February 1984 do we think that it would have been literally and absolutely impossible for the Contractor to have carried out thereafter (doubtless with some additional delay) the 10-15% of the Contract work which remained to be done at the Airport. It is not literally or absolutely impossible that one who sets out to cross an uncharted mine-field will safely reach the other side.

But in a commercial bargain one is concerned with pragmatic rather than abstract considerations — with commercial practicability rather than theoretical possibility. Where events beyond the control of either side supervene which merely render performance financially more onerous for a contracting party he will not, under most systems of law, be excused from further performance or (in the absence of some special contractual or statutory provision — nowadays not infrequently to be found) entitled to insist upon extra compensation […].

But events which go beyond merely increasing the financial burden on the party performing, and which reach a point where they render performance unacceptably hazardous to the lives and safety of those performing, are in a different category altogether.

The issue of irresistibility has been dealt with also in the ICC award National Oil v Sun Oil decided in 1985,²⁹ where the US company Sun Oil, notified its counterpart that certain US passport and export regulations, enacted after the conclusion of the [Page129:]Exploration and Production Sharing Agreement, amounted to a force majeure event which prevented the performance of the contract. Although not expressly mentioned in the force majeure clause agreed between the parties,³⁰ the arbitrators decided that the requirement of irresistibility should be implied and should be interpreted strictly. Having furthermore considered that other companies, in the same situation, had been able to overcome the obstacle. the arbitral tribunal concluded as follows:

The test to be applied here is whether a reasonable person placed in the same circumstances as the party seeking to be excused would have been able, despite the supervening event, to perform the contract. Normally, the judge must refer to a theoretical reasonable person. In this case, there is an unusual situation in which parties placed in the same circumstances exist in reality and have been able to overcome the supervening obstacle to performance. It would be most difficult to accept that another similarly situated party can successfully rely on that same obstacle as a ground of force majeure. It is to be concluded that the US Export Regulations enacted on 12 March 1982 did not constitute for Sun Oil an event of force majeure excusing the discontinuance of exploration for such time as such regulations would remain in force, whether viewed separately or in conjunction with the Passport Order.³¹

6.5.1.3 Force majeure clauses and rules of the applicable law

In order to avoid the uncertainties caused by the existence of conflicting rules on this crucial subject matter, parties normally prefer to deal with it directly by incorporating a force majeure clause into the contract itself.

The force majeure clause agreed contractually will often have a wider scope than the criteria generally accepted in national laws. The clause may, for instance, provide more flexible criteria for evaluating the requirement of irresistibility (through the inclusion of the reasonableness criterion) or expressly mention situations which might not necessarily amount to force majeure (like, for instance, non-delivery by sub-suppliers). In some cases, the clause does not mention at all certain requirements, such as foreseeability or irresistibility.

In principle, parties are free to decide the force majeure conditions, and their agreement will prevail over the criteria dictated by the applicable law (which will normally not be mandatory). However, when the clause does not mention certain basic requirements, the arbitrators may conclude, especially in case of a poorly drafted clause, that the parties did not intend to exclude the requirements which were not expressly mentioned.

Thus, in the Sun Oil case (supra, § 6.1.5.2), where the arbitration clause did not mention the irresistibility requirement, the arbitrators decided that the clause was vague and that due to the ambiguity of the clause:

… it would be unjustified, in the absence of any specific provision to such effect in Art. 22, to construe such article as revealing an intent of the parties to waive an essential rule of Libyan common law according to which force majeure is only established when the event invoked by the defaulting party created an impossibility to perform whether on a temporary or a permanent basis.³²

In other cases, where the force majeure clause did not mention the foreseeability requirement, the arbitrators have decided that the exemption from liability should apply even if the event was foreseeable, without considering the stricter definition of force majeure definition provided the applicable law.

Thus, in a recent case regarding a Production Sharing Agreement between two oil companies and the Republic of Yemen,³³the force majeure clause did not mention the foreseeability requirement. The Republic of Yemen sustained that such requirement [Page130:]should be read into the force majeure clause as part of Yemeni law, but the arbitrators rejected the argument arguing that the agreement provided a self-contained definition of force majeure, which prevailed over the legal definition.³⁴ In another case,³⁵ where the foreseeability requirement had been omitted, the arbitrators decided that, independently of Spanish law which was applicable and which provided the requirement of foreseeability, the force majeure would apply as well to foreseeable events, provided such events were insurmountable and beyond the control of the parties.

It should in any case be considered that, even where the force majeure clause does not mention foreseeability, it would in fact be difficult to apply the clause in case of clearly foreseeable events, since it is may be presumed in this case that the obligor assumed the risk of its occurrence.³⁶

6.5.1.4 Drafting the force majeure clause

Force majeure clauses can be drafted in various ways, but the prevailing structure is to provide a general definition of force majeure, followed by a list of events which are to be considered to amount to force majeure (war, fire, etc.) and, finally, the consequences of force majeure, i.e. the exemption from liability of the party that cannot perform due to force majeure.

Sometimes, the force majeure clause only refers to a number of events without giving a general definition of the term, as in the following clause:

Force majeure clause (US contract)

Neither Party shall be liable, or be deemed to be in default, to the other Party hereunder by reason or account of any delay or omission caused by epidemic, fire, power outages, action of the elements, strikes, lockouts, sabotage (except as caused by a Party’s employees or agents), labor disputes, governmental law, regulations, ordinances, order of a court of competent jurisdiction, executive decree or order, act of God or public enemy, war, riot, civil commotion, earthquake, flood, explosion, casualty, embargo or any other similar cause beyond the control of such Party (each, a “Force Majeure Event”).

In principle, the above type of clause is not to be recommended for several reasons. First, it does not contain a general definition of force majeure. Consequently, possible events not expressly listed may qualify as force majeure only if they are “similar” to those listed and beyond the control of a party. Second, there is no indication that the event should not be foreseeable, which may widen the scope of the clause too much and include events that should not exempt the party concerned from liability. Third, it is not clear whether the requirement that the event must be beyond the control of the party concerns only events not expressly listed, or also includes those in the list (for example, would a labour dispute be covered even when it is not beyond the party’s control?).

The above considerations demonstrate that a good force majeure clause needs careful drafting and should not simply be copied from an existing contract, as is the case too frequently in practice. Since it is not always possible to find the time to work out an appropriate force majeure clause — especially when this does not appear to be crucial for the negotiators — it may be advisable to have recourse to a good standard clause, such as the ICC Force Majeure Clause 2003.³⁷

6.5.1.5 The ICC Force Majeure Clause 2003

The ICC Force Majeure Clause 2003, drafted by a group of qualified experts from different countries, deals in detail with most issues arising in this context.

[Page131:]The clause can be used as an example for drafting an individual clause, or can be incorporated by reference in the contract through a provision referring to it, such as the following:

Clause incorporating the ICC Force Majeure Clause 2003

The ICC Force Majeure clause 2003 is incorporated by reference into this CONTRACT.

The structure of the clause

The ICC Force Majeure Clause contains a general definition of force majeure, indicating the three basic requirements, and a list of events which are normally considered as implying force majeure.

According to the general definition of force majeure contained in the first paragraph of the ICC clause, a party is relieved from its duty to perform its obligations if and to the extent that that party proves:

1. that its failure to perform was caused by an impediment beyond its reasonable control; and
2. that it could not reasonably have been expected to have taken the occurrence of the impediment into account at the time of the conclusion of the contract; and
3. that it could not reasonably have avoided or overcome the effects of the impediment.

An interesting feature of the ICC clause is the reference to reasonableness. Thus, an impediment which could in theory be overcome will nevertheless be qualified as force majeure if it would be unreasonable to request the party in question to overcome its effects.

The second paragraph deals with a particular issue, i.e. to what extent the non-performance by a third party (sub-supplier, sub-contractor) which prevents the contracting party to fulfil its obligations, can be considered as a force majeure event for the contractor. According to this provision, the contractor must not only prove that the requirements of force majeure are met, but also that the same requirements apply to the third party.

The relationship between the general definition and the listed events

When introducing a list of force majeure events in the clause, the question arises whether the list of events should be merely illustrative (which means that the obligor invoking the listed event should prove at the same time that the general requirements of force majeure are met) or, on the contrary, the occurrence of the event as such should be sufficient to relieve the obligor from its duty to perform.

As regards the ICC Force Majeure Clause, the third paragraph lists a number of typical events of force majeure, such as war, acts of terrorism, sabotage, piracy, acts of God, general labour disturbances, etc., in conformity with the commonly used type of approach with respect to this type of clause.

With respect to the relationship between the listed events and the general definition of force majeure, the clause has opted for a compromise solution, by stating that in the absence of proof to the contrary and unless otherwise agreed in the contract between the parties expressly or impliedly, a party invoking the clause shall be presumed to have established the two first conditions of the general definition (i.e. that the event is unforeseeable and beyond its control) but must in any case prove the requirement of irresistibility.

In other words, the listed events are subject to the same conditions established in the general force majeure formula, but the party invoking them will benefit from the above presumption with respect to the first two requirements, thus shifting the burden of proof to the other party. [Page132:]

Consequences of force majeure

Paragraph 4 of the clause expressly states that a party successfully invoking the clause is relieved of its duty to perform its obligations under the contract from the time at which the impediment causes the failure to perform if notice thereof is given without delay, or if notice thereof is not given without delay, from the time at which notice thereof reaches the other party. The obligation regarding notification is very important, because it makes the effect of the clause dependant upon timely information from the other party and thus prevents a party from seeking at a later stage excuses for its non-performance.

Moreover, according to paragraph 5, the party successfully invoking the clause is relieved from any liability in damages or any other contractual remedy, from the time it notified the event to the other party.

6.5.2 Hardship

While force majeure mainly concerns situations where performance is made impossible or “reasonably” impossible, the notion of hardship covers the situation in which, due to an unforeseeable event beyond the control of the parties, the equilibrium of the contract is substantially altered and the performance becomes excessively onerous for one of the parties. Typical examples of hardship are extreme devaluations of a currency or very substantial price increases of certain goods, which radically modify the circumstances considered by the parties when concluding the contract. Another hardship situation arises where the contract unexpectedly loses any interest it had for a party, e.g. because the goods are no longer marketable.

According to the generally accepted principle of contract law, whereby the parties are bound to respect the obligations undertaken (pacta sunt servanda) and to take the risk that the deal may become less profitable or even incur a loss, hardship situations should in principle not entitle the disadvantaged party to be freed from its obligations nor to claim that the contractual conditions be modified so as to restore the previous equilibrium.

However, this restrictive view — which takes into due consideration the need for foreseeability and certainty — may be overcome when it is necessary to safeguard the interest of a party that suffers an exceptional and unforeseeable change of circumstances. There is a trend in national laws to recognize that in serious situations of hardship a party may be entitled to renegotiate the contract and/or to obtain judicially its adaptation,³⁸ or at least its termination.³⁹

A rather wide acceptance of the principle of hardship is contained in Articles 6.2.2- 6.2.3 of the UNIDROIT Principles.

Clauses on Hardship in the UNIDROIT Principles

Article 6.2.1 – (Contract to be observed)

Where the performance of a contract becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations subject to the following provisions on hardship.

Article 6.2.2 – (Definition of hardship)

There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and

1. the events occur or become known to the disadvantaged party after the conclusion of the contract;
2. the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;
3. the events are beyond the control of the disadvantaged party; and[Page133:]
4. the risk of the events was not assumed by the disadvantaged party.

Article 6.2.3 – (Effects of hardship)

1. In case of hardship the disadvantaged party is entitled to request renegotiations. The request shall be made without undue delay and shall indicate the grounds on which it is based.
2. The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
3. Upon failure to reach agreement within a reasonable time either party may resort to the court.
4. If the court finds hardship it may, if reasonable,

1. terminate the contract at a date and on terms to be fixed, or
2. adapt the contract with a view to restoring its equilibrium.

The UNIDROIT Principles on hardship have been criticized because they give too much latitude to a party wishing to be freed from its obligations and especially because they give a third party (arbitrator or judge) the power to change the conditions of contract in order to restore the previous balance of the respective obligations.

This issue has already been considered when dealing in general terms with the UNIDROIT Principles (supra, § 2.8.2.3). Business people tend to reject the idea that a third party may modify the essential elements of their contract, such as the price, without their consent. Of course, parties may in exceptional situations entrust a third party (e.g. an arbitrator) with the task of determining certain contractual issues, but this will normally be agreed with respect to a specific situation through a clause drafted for that particular purpose.

It is interesting to note that a far more cautious approach has been taken in the ICC Hardship Clause 2003, which is reproduced below.

ICC Hardship Clause 2003

1. A party to a contract is bound to perform its contractual duties even if events have rendered performance more onerous than could reasonably have been anticipated at the time of the conclusion of the contract.
2. Notwithstanding paragraph 1 of this Clause, where a party to a contract proves that:

1. the continued performance of its contractual duties has become excessively onerous due to an event beyond its reasonable control which it could not reasonably have been expected to have taken into account at the time of the conclusion of the contract; and that
2. it could not reasonably have avoided or overcome the event or its consequences,

the parties are bound, within a reasonable time of the invocation of this Clause, to negotiate alternative contractual terms which reasonably allow for the consequences of the event.

3. Where paragraph 2 of this Clause applies, but where alternative contractual terms which reasonably allow for the consequences of the event are not agreed by the other party to the contract as provided in that paragraph, the party invoking this Clause is entitled to termination of the contract.

Under the ICC Hardship Clause, the parties have the duty to negotiate alternative reasonable terms, but if they fail to agree upon a mutually satisfactory solution, no third party will take their place and the only consequence will be termination of the contract.

This compromise solution seems to be a more appropriate response to the needs of the parties. If a hardship situation arises, the parties will have a good chance to agree upon a reasonable solution. When the parties cannot reach an agreement, the disadvantaged party will, in any case, be able to bring the issue before the competent court or arbitral tribunal. However, this court or arbitral tribunal can only decide on termination of the contract (if the conditions for hardship are met), and cannot take the parties’ place by “redrafting” the contract on their behalf. [Page134:]

In this way, the party suffering the hardship situation will be freed from obligations it could not reasonably be expected to perform due to the change of circumstances and, at the same time, the danger will be avoided of a third party interfering with decisions that parties want to reserve for themselves.

6.5.3 Penalty/liquidated damages

Penalty (or liquidated damages) clauses are clauses under which a party undertakes to pay, in case of non-performance of a specific obligation, a pre-established sum of money normally calculated as a percentage of the value of the obligation which has not been performed or has not been timely performed.

Clauses of this type can have three different functions:

1. to determine in advance the amount of the damage to be compensated, so that the party suffering the breach need not prove the amount of its loss;
2. to induce the other party to perform its obligations, under the pressure of a monetary penalty;
3. to limit the liability for damages to the amount of the penalty/liquidated damages.

6.5.3.1 Validity and effectiveness of penalty clauses in civil law and common law

While the function of determining the damage in advance is generally accepted in most legal systems, the second one, i.e. that of inducing the counterpart to perform, is not admitted in most common law countries, which do not accept the idea that a party may secure performance of a contract by the imposition of a fine or penalty and only admit the fixing of the amount in advance as “liquidated damages”. This implies that clauses which specify amounts of liquidated damages which are not a genuine pre-estimate of loss, and which are aimed at deterring a breach instead of determining in advance future damages, are to be qualified as penalties, and will be considered null and void.

According to the traditional view prevailing in English case law, a liquidated damages clause is to be qualified as an (invalid) penalty clause when it is intended to operate in terrorem and its amount appears to be unconscionable or extravagant.

However, in a recent case the Supreme Court⁴⁰ has opted for a more flexible approach, replacing the traditional test of whether the clause is a “genuine pre-estimate of loss” and therefore compensatory, or whether it is aimed at deterring a breach and therefore penal, with the test whether the clause is out of all proportion to the innocent party’s legitimate interest in enforcing the counterparty’s obligations under the contract.

Thus, under this new jurisprudence, the fact that the purpose of the clause is aimed at deterring a breach of contract is not sufficient: what counts is that it the innocent party has a legitimate interest in enforcing performance and that the amount agreed is not out of proportion to that interest. This means that a party can, in some circumstances, enforce a consequence for non-performance which goes beyond simply being compensated for losses, where that party’s wider legitimate interests justify such compensation.

The flexible approach introduced by the Supreme Court has significantly reduced the gap existing between common law and civil law. In fact, in most civil law systems penalty clauses are not unlawful, but the courts have the right to reduce the amount of the penalty if it is excessive, as shown hereafter with regard to France.⁴¹

Article 1231-5 - New French Civil Code

Lorsque le contrat stipule que celui qui manquera de l’exécuter paiera une certaine somme à titre de dommages et intérêts, il ne peut être alloué à l’autre partie une somme plus forte ni moindre.

Néanmoins, le juge peut, même d’office, modérer ou augmenter la pénalité ainsi convenue si elle est manifestement excessive ou dérisoire.

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Where the contract provides that the party which does not perform will pay a certain amount as damages, no higher or lower amount can be granted to the other party.

However, the judge may, even on its own initiative, reduce or increase a penalty which is manifestly excessive or derisory.

Also, the UNIDROIT Principles provide in Article 7.4.13(2) that, notwithstanding any agreement to the contrary, the specified sum may be reduced to a reasonable amount when it is grossly excessive in relation to the harm resulting from the non-performance and to other circumstances.

UNIDROIT Principles - Article 7.4.13 - Agreed payment for non-performance

1. Where the contract provides that a party who does not perform is to pay a specified sum to the aggrieved party for such non-performance, the aggrieved party is entitled to that sum irrespective of its actual harm.
2. However, notwithstanding any agreement to the contrary the specified sum may be reduced to a reasonable amount where it is grossly excessive in relation to the harm resulting from the non-performance and to the other circumstances.

We can therefore conclude that it is advisable at least where the contract is to be governed by the law of a common-law country, to avoid the term “penalty” and, generally, to fix possible liquidated damages at reasonable levels, thus reducing the risk of a qualification as penalty (under common-law legal systems) and the risk of having the amount reduced by the courts (under civil law legislations).

6.5.3.2 Liquidated damages and limitation of liability

As regards the third function, i.e. the limitation of liability, the solutions found in national laws differ from country to country. In some jurisdictions the general rule (applicable if parties have not agreed otherwise) is that the aggrieved party may claim further damages if it is able to prove them.⁴² In others, unless otherwise agreed, the liquidated damages are the maximum amount that can be claimed.⁴³

These differences can have surprising consequences as shown in the following example.

The above example clearly shows how important it is to consider the applicable law (even where the Convention on the International Sale of Goods is applicable, since the penalty clause remains outside the scope of the CISG: see infra, § 7.3.1.1).

The recourse to penalty/liquidated damages in case of delay in delivery is quite common in general conditions of sale as a compromise solution, which grants the buyer a compensation for the damage suffered and at the same time provides a limitation of liability for the seller. When the clause has this double purpose, parties should make sure to expressly state that the liquidated damages are the only remedy in case of delay in delivery.⁴⁴

6.5.3.3 Recommendations to negotiators

• Whenever the contract may be submitted to a common-law country, it is advisable to use the term liquidated damages instead of penalty.
• When agreeing on the amount of the penalty/liquidated damages, parties should specify an amount which is reasonable, taking into account the possible consequences of an excessive amount under the law applicable to the contract.
• If the parties wish that the penalty/liquidated damages also imply a limitation of liability, parties should check the applicable law and, if necessary, expressly state whether they intend to limit liability to the amount of the penalty.

6.5.4 Requirement of written form for modifications

It is a common practice to include clauses which provide that any future changes to the contract must be made in writing or, in more exceptional cases, that they must be made by a separate document signed by both parties.⁴⁵

An example of a clause requiring a signed document is the following:

Clause requiring signed document for modifications

Except as otherwise provided herein, this Agreement can only be modified by a written agreement signed by authorized representatives of both parties.

Clauses of the above type are rather exceptional and should be used only where the parties have good reasons for requiring that any modification should be recorded on a separate written agreement. This can be for instance the case where the performance of certain aspects of the contract is entrusted to several people and the parties want to make sure that only some of them can agree on modifications on behalf of the company.

The clause commonly used will only state that an agreement in writing is necessary, so that an exchange of letters or e-mails can be sufficient, as in the following clause:

Written form for modifications

Any amendment to this Contract must be in writing.

The purpose of these clauses is to induce parties to use the written form whenever they modify their agreement in order to avoid possible misunderstandings and to maintain evidence of the successive agreements.

However, provisions of this type do not always correspond to actual business needs. Especially in countries where commercial contracts do not require the written form, traders are used to agreeing on many issues orally, e.g. by phone. Thus, it is frequent, [Page137:]for example, in commercial agency contracts that the parties will agree orally upon a higher or lower rate of commission for a particular deal or that they will agree to include business made outside the contractual territory within the scope of the contract.

This possible gap between the common practice of the parties and the contractual rule requiring the written form may give rise to inequitable results, particularly when a party that apparently agreed with, or even proposed, the oral modification thereafter claims that the modification is invalid because it does not comply with the written form requirement.

In some jurisdictions, the courts avoid this result by stating the principle that by orally agreeing to modifications of the contract, the parties implicitly waive the rule that requires the written form.

Article 29(2) of the UN Convention on the International Sale of Goods (CISG) states the following:

Article 29(2) - CISG

A contract in writing which contains a provision requiring any modification or termination by agreement to be in writing may not be otherwise modified or terminated by agreement. However, a party may be precluded by his conduct from asserting such a provision to the extent that the other party has relied on that conduct.

This rule, which can be considered as an application of the general principle of good faith, means that once one party gives the other party reasons to rely on the fact that it agrees to modify the contract orally, for instance, by proposing the modification itself, it loses the right to invoke the nullity of such modification not being made in writing.

The same rule is contained in the UNIDROIT Principles.

UNIDROIT Principles - Article 2.1.18

A contract in writing which contains a clause requiring any modification or termination by agreement to be in a particular form may not be otherwise modified or terminated. However, a party may be precluded by its conduct from asserting such a clause to the extent that the other party has reasonably acted in reliance on that conduct.

6.5.5 Partial nullity

Clauses stating that the nullity of one or more clauses does not imply the nullity of the whole contract are very common in international agreements.

Some typical examples of such provisions are the following:

Severability of provisions

The terms of this Agreement are severable and the invalidity of any term of this Agreement shall not affect the validity of any other term.

Partial nullity

If any provision of this Agreement is held by a court of competent jurisdiction to be unenforceable, such decision shall not affect the validity or enforceability of any of the remaining provisions, which remaining provisions shall continue to have full force and effect.

Invalid clauses

Any provision to be found invalid or unenforceable shall not affect the validity of the contract as a whole.

Clauses such as the above are included for the purpose of saving the contract as a whole when one of its clauses appears to be null and void. However, this may not always conform to the needs of a party, as shown in the following example.

In the above example, the export prohibition is essential for the licensor, and the clause stating that the nullity of any clause does not affect the remaining provisions of the contract is not appropriate for him. According to a rule which exists in most jurisdictions, if the above clause had not been in the contract, the party would have claimed that the nullity of the export prohibition should imply the nullity of the contract as a whole, since he would not have concluded the contract if he had known the clause was invalid.

It is therefore better not to include clauses such as those mentioned above, or at least to make clear that the contract must be considered null and void in its entirety, whenever the nullity regards an essential clause.

Another useful provision that may be included is to expressly provide an obligation to negotiate alternative clauses that may replace the ineffective clause without breaching the law, as provided in the following example:

Invalid clauses

If any of the provisions of this Agreement are found to be null and void, the remaining provisions of this Agreement shall remain valid and shall continue to bind the Parties, unless it can be concluded from the circumstances that, in the absence of the provision(s) found to be null and void, the Parties would not have concluded the present Agreement. The Parties shall replace all provisions found to be null and void by provisions that are valid under the applicable law and come closest to their original intention.

6.5.6 Non-waiver clauses

Another common clause is one providing that the failure by one party to require performance of its obligations by the other party cannot be considered as a waiver of its future rights, as in the following example:

Non-waiver

The failure of either party hereto at any time to require performance by the other of any provision hereof shall in no way affect the full right to require such performance at any time thereafter; nor shall the waiver by either party of a breach of any provision hereof constitute a waiver of any succeeding breach of the same or any other provision hereof, or constitute a waiver of the provision itself.

The effectiveness of this clause may be very different depending on the applicable law. While it is likely that the clause will be applied strictly in jurisdictions favouring a literal interpretation of the contractual clauses (e.g. England), in many civil law jurisdictions the clause will not be applied when it is clear that the failure to observe a certain obligation has been tolerated by the other party in the past.

A typical example of this problem arises when a party wishes to terminate a long-term contract “for cause”, invoking the breach of an obligation expressly mentioned in the contract as a condition for contract termination without notice. If this obligation has never been respected in the past (for example, the obligation to transmit certain information at regular intervals which has never been adhered to for several years), and the other party has never complained about it, there is little chance that a civil law jurisdiction would consider the termination based on such contractual breach as valid, even if the contract contains a non-waiver clause.

This is why the effectiveness of these clauses should not be overestimated and, when there is an risk that the failure to require the performance of a specific obligation can be interpreted as a waiver, a specific clause to that effect — which will have far more chance of being effective — should be drafted. [Page139:]An example of this situation can be found in the following clause, which makes clear that when the supplier decides not to enforce the minimum turnover clause (a situation which is quite frequent in practice), this does not imply a waiver of his right to do so in the future.

Minimum turnover clause

The Distributor undertakes to purchase, each year, Products amounting to at least the minimum yearly turnover indicated in Annex A-3.

If the Distributor fails to attain before the end of any year the minimum purchase in force for such year, the Supplier shall be entitled, by notice given in writing by means of communication ensuring evidence and date of receipt (e.g. registered mail with return receipt, special courier), at his choice, to terminate this Agreement, to cancel the Distributor’s exclusivity or to reduce the extent of the Territory.

It is expressly agreed that any decision by the Supplier not to make use of the above rights in case of non-attainment of the minimum turnover by the Distributor, even if repeated for several years, will not be considered as a waiver of its right to invoke the same clause in the future.

6.5.7 Clauses excluding liability for consequential damages

In order to limit liability for possible damages arising out of non-performance, traders tend to provide clauses which exclude liability for certain kinds of less direct damages, such as loss of profit, lost sales, loss of production, etc.

A clause commonly used in international contracts is the following:

Limitation of liability – consequential damage

Neither party shall be liable to the other for any consequential damage with respect to any claim arising out of this agreement.

Parties using this type of clause normally intend to exclude their liability for damages that may be a further consequence of their non-performance, like, loss of production, loss of profit, etc. It is however not at all certain that a clause of this type will warrant such result, since the notion of consequential damages is ambiguous and does not necessarily cover the types of damage that the parties intended to exclude.

First of all, it should be said that the term “consequential damage” does not exist as a legal notion in civil law jurisdictions. Thus, if the contract is governed by the law of a country of civil law, it is not foreseeable which type of damage may fall under the clause and be excluded from liability.

But also under common-law legal systems, where the notion of consequential damages exists, its actual meaning is not clearly defined.

According to the traditional approach of English Courts, which has been followed in most common-law countries, when a party breaches the contract, the other party is entitled to receive damages:

• which fairly and reasonably arise naturally from the breach of contract (direct loss); and
• which were reasonably in the contemplation of both parties, at the time they made the contract, as the probable result of the breach of it (consequential or indirect loss).

However, when it comes to decide if a specific damage can be considered to be direct or consequential, the question cannot be answered in general terms, but will depend on the circumstances of each case. Thus, if we take for instance the common case of loss of profits, the answer depends on the circumstances of the specific agreement: in some cases, it will be considered to be a direct loss, arising naturally from the breach of contract; in others, it may be considered as a consequential or indirect loss.

This issue has been dealt with by the New York Court of Appeals in Biotronik AG v Conor Medsystems Ireland Ltd.⁴⁶where the court held that the lost profits arising from a collateral contract with a third party constituted general (direct) damages and was not exempted by a “consequential damage” exclusion clause.

[Page140:]

This case highlights the importance of specifically identifying lost profits in limitation of liability clauses and not just relying on a general reference excluding consequential damages.

It is therefore recommended to always expressly mention, in addition to the reference to consequential damages, the specific loss that is to be excluded, like loss of profit, loss of production, lost sales, loss of opportunity, loss of business, additional costs sustained for overcoming the consequences of the breach, etc., in order to make clear that this type of losses is to be excluded in any case.

Finally, it should be reminded that in most civil law countries limitations of liability are ineffective in case of fraud of gross negligence.

Concluding the Contract

The rules concerning the conclusion (formation) of contracts are a striking example of the distance existing between legal rules and the expectations of business.

Thus, in most legal systems the application of the so-called “mirror image rule” may have practical consequences that the parties do not foresee, as shown in the next paragraph. And the consequences of this gap between the law and contractual practice are even greater in case of conflicting general conditions, as explained later in § 6.7.

6.6.1 The domestic rules of formation of contracts and resulting problems

Most national legal systems, when dealing with contracts concluded through an exchange of communications between parties located in different places — which is a very common situation, particularly with respect to international contracts — follow more or less strictly the so-called “mirror image rule”, whereby the acceptance of an offer must exactly conform to the terms of such offer. If this is not the case, the purported acceptance will be considered to be a counter-offer that must, in turn, be accepted by the other party.

An example can be useful for a better understanding of this issue.

In a situation of this kind, the obvious conclusion of a businessman not versed in legal problems is that a contract has been validly concluded and that consequently System Watch can put the watches into production, knowing that Mr Bigault is obliged to take delivery of them, while Mr Bigault can enter into agreements with his customers on the assumption that System Watch has undertaken to deliver the watches on 30 June.

In fact, the above conclusion would not be the case in many legal systems. Most jurisdictions follow the principle that a proposal is accepted, and amounts to the conclusion of a contract, only where the acceptance exactly corresponds to the proposal. If there are differences or exceptions, the answer to the proposal is not to be qualified as acceptance, but as a counterproposal, and the contract will be concluded only when the other party accepts such counterproposal.⁴⁷

Some legal systems have a more flexible approach in admitting that a contract may be concluded when the modifications contained in the acceptance regard merely accessory aspects or do not materially alter the offer.

For example, Article 2-207 of the US Uniform Commercial Code states the following:

1. A definite and reasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms.
2. The additional terms are to be construed as proposals for addition to the contract. Between merchants such terms become part of the contract, unless:

2. the offer expressly limits acceptance to the terms of the offer;
3. they materially alter it; or
4. notification of objection to them has already been given or is given within a reasonable time after notice of them is received.

We can therefore conclude that the resolution of this critical issue will depend upon the law governing the formation of the contract. According to the rules prevailing in Europe, such law will be the law that would govern the contract if it were concluded. This results from Article 10(1) of the Rome I Regulation of 2008, which provides as follows:

The existence and validity of a contract, or of any term of a contract, shall be determined by the law which would govern it under this Regulation if the contract or term were valid.

However, different rules of private international law, such as, for example, the direct application of the lex fori, may apply in other countries.

This means that, when problems concerning the conclusion of the contract arise, it will not always be easy to obtain a clear answer: first, because there may be a problem of identifying the law which governs the formation of the contract in dispute and second, because the rules on formation are often complex and difficult to interpret.

It should be noted, however, that disputes on these points are far less frequent than one would imagine. In most cases where the contract has not been concluded regularly, because the offeror was not aware that what he thought to be an acceptance was actually a counterproposal, he will thereafter accept the counterproposal without noticing the difference, simply by behaving as if the contract had already been concluded.

Thus, in the case of example 6-8, when the subsequent behaviour of the buyer necessarily implies acceptance of the contract (e.g. the issue of the documentary [Page142:]credit), it will in most legal systems be considered to be a tacit acceptance of the counterproposal. This means that in all cases where the parties continue performing the deal, they will sooner or later give rise to a situation in which the contract can be considered as concluded.

Problems will mainly arise when one of the parties changes its mind before the contract is validly concluded. In order to better understand this, we can continue citing example 6-8.

In cases such as this, which are, fortunately, rather exceptional (because parties do not frequently challenge the effectiveness of the conclusion of a contract before performing it, or before it is performed by the other party), the application of the principles on formation may have serious consequences for the party that was relying upon the valid conclusion of the contract. This is why it is important for business people to have some understanding of the rules governing contract formation, and particularly those concerning acceptance with modifications.

6.6.2 Rules on the formation of contracts in the CISG and UNIDROIT Principles

In the previous paragraph, reference was made to the rules on formation of contracts contained in national laws.

However, in actual practice most problems will arise in the context of contracts of sale, which are the main example of contracts negotiated between distant persons. Since a great number of countries have ratified the UN Convention on the International Sale of Goods (CISG), the situation most likely to arise is that this Convention and its rules on the formation of contracts of sale will apply.

Thus, in the case examined in the previous paragraph, reference should be made to the CISG, since both Belgium and Switzerland have ratified the Vienna Convention of 1980.

As regards the acceptance problem examined in the previous paragraph, we should first mention Article 18(1) of the CISG.

Article 18(1) - CISG

A statement made by or other conduct of the offeree indicating assent to an offer is an acceptance. Silence or inactivity does not in itself amount to acceptance.

It is therefore clear that in cases where a purported acceptance is actually to be considered as a counter-offer, such counter-offer will be considered to have been accepted as soon as the conduct of the other party indicates its assent.

As regards the possibility of qualifying as acceptance a reply to an offer which contains modifications of limitations or additions, Article 19 should be considered.

Article 19 - CISG

1. A reply to an offer which purports to be an acceptance but contains additions, limitations or other modifications is a rejection of the offer and constitutes a counter-offer.
2. However, a reply to an offer which purports to be an acceptance but contains additional or different terms which do not materially alter the terms of the offer constitutes an acceptance, unless the offeror, without [Page143:]undue delay, objects orally to the discrepancy or dispatches a notice to that effect. If he does not so object, the terms of the contract are the terms of the offer with the modifications contained in the acceptance.
3. Additional or different terms relating, among other things, to the price, payment, quality and quantity of the goods, place and time of delivery, extent of one party’s liability to the other or the settlement of disputes are considered to alter the terms of the offer materially.

This provision, after having reinstated the traditional “mirror image” rule in paragraph 1, attempts to introduce some flexibility in the second paragraph by admitting an acceptance with modifications, provided the material terms of the offer are not altered. However, this rule is practically annulled by the third paragraph, which considers almost any type of modification as materially altering the offer.

Therefore, if we look at the clause as a whole, it would seem that the CISG substantially maintains the traditional “mirror image” approach.

In actual fact, the above conclusion is not completely true if we consider that in several cases the courts have considered as not materially altering the contract terms modifications that were apparently covered by § 3 of Article 19. For example, the following have been qualified as immaterial modifications: a clause reserving to the seller the right to change the period of delivery,⁴⁸ revision of the price according to market trends,⁴⁹ a 30-day time limit for notice of defects.⁵⁰

The UNIDROIT Principles contain in Article 2.1.11 the same text of the first two paragraphs of Article 19 of CISG, but not the third paragraph. This means that under the UNIDROIT Principles, a modified acceptance is possible if the modifications are not material and the evaluation of this requirement is left to the courts.

The UNIDROIT Principles also contain a provision on “writings in confirmation” that may give rise to problems, at least for traders not used to this type of practice.

UNIDROIT Principles – Article 2.1.12 - Writings in confirmation

If a writing which is sent within a reasonable time after the conclusion of the contract and which purports to be a confirmation of the contract contains additional or different terms, such terms become part of the contract, unless they materially alter the contract or the recipient, without undue delay, objects to the discrepancy.

This provision seems to be inspired by a practice common in certain countries (particularly Germany) according to which a party, after having orally concluded a contract, sends a confirmation in writing containing additional clauses normally related to the typical legal aspects, and often based on its general conditions. However, the term confirmation is a fiction, because the party in question is actually adding new terms after the agreement has been made,⁵¹ which would mean, in most jurisdictions, that it is actually proposing to change the terms of a contract which has already been concluded.

An interesting example of the above situation can be found in a case decided in 2003 by a US Federal Court.

The above example shows that the rule contained in Article 2.1.12 of the UNIDROIT Principles may not be appropriate for parties who are not used to the practice of confirmation letters. In any case, since the additions contained in the confirmation letter can be effective only if they do not materially alter the terms of the contract, this rule should not apply to a case in which the confirmation in writing contains the general conditions of the party sending it, since general conditions practically always contain clauses which imply material modifications to the legal rules (concerning, for example, limitations of liability, resolution of disputes, etc.).

Moreover, it is unlikely that the rules concerning formation of contracts contained in the UNIDROIT Principles may actually be applied. In fact, where the parties have chosen to incorporate the Principles by reference into their contract, by agreeing that such principles will govern the contract, the Principles cannot decide the issue of whether the contract incorporating them has been validly concluded. This is because the Principles can only apply if the agreement of the parties that incorporates them exists, unless there is a previous agreement whereunder the parties have agreed to apply the Principles to future contracts. This means that the rules on formation contained in the UNIDROIT Principles will mainly be applicable where they are considered by arbitrators to be part of the lex mercatoria rather than in case of contractual incorporation.

6.6.3 Conclusion of contracts and general conditions

While more complex international agreements are normally negotiated in detail and result in a more or less tailor-made contract, simple sales contracts tend to be standardized, i.e. a party will prepare a set of conditions to be used for all contracts of a certain type.

This type of practice is normal for sales contracts regarding goods sold on a continuing basis, but is also common in the banking and insurance business.

As regards the contract of sale, which is the most common example of use of general conditions, the seller (or the buyer) works out a set of contractual clauses, mainly covering the strictly legal issues of the contract (for instance, choice of jurisdiction, warranties, limitation of liability, etc.), which are added to the “special part” of the contract proposal containing the issues negotiated case by case.

Therefore, it is a common practice that the parties will negotiate and agree upon a number of issues (goods sold, price, date of delivery, conditions of payment, etc.) and refer the other issues to a set of pre-established conditions, their conditions of sale or of purchase, as the case may be.

In doing so, the negotiators, who are not lawyers, will only deal with the “commercial” issues and need not consider the strictly “legal” issues which are taken into account in their general conditions.

The usual way of doing this is to exchange documents (offer, acceptance, offer confirmation) where the “commercial” issues negotiated between the parties are expressly indicated on the front page and, for all the others, a reference is made to the general conditions (normally written on the back of the document or attached to it). Now, with the increasing use of e-mails as means of communication, it has become easy to annex the general conditions in the respective offer or acceptance, thus facilitating the proof that the conditions were effectively made known to the counterpart.

The recourse to general conditions gives rise mainly to the following critical issues:

[Page145:]

1. where the inclusion of general conditions has not been clearly agreed between the parties, and especially when both parties make reference to their own general conditions (which are, by definition, contradictory), the question arises as to whether the conditions of one of the parties have become part of the contract (infra, 6.6.3.1);
2. where the clauses of the general conditions have not been negotiated between the parties, but simply accepted as an imposition by the stronger party, certain rules protecting the other party may limit the effectiveness of these standard terms (infra, § 6.6.4).

6.6.3.1 When do general conditions become part of the agreement?

Where the contract containing the general conditions is signed by both parties — a common situation for banking or insurance contracts, where the stronger party has the power to require the other party to sign — there are no particular problems (except from the point of view of protecting such other party: see, infra, 6.6.4).

When, on the contrary, the contract is concluded through a written exchange (letters, faxes, e-mails), it is not always clear if the general conditions to which the parties have referred in these communications have become part of the contract, and consequently whether their provisions, which normally strongly favour the party that drafted them, have become part of the contract.

This is a particularly crucial issue that may substantially change the parties’ respective positions in case of dispute.

We will first examine the case where only one party refers to its general conditions, and thereafter the even more critical situation that arises when both parties refer to their own (conflicting) conditions, the so-called battle of forms.

6.6.3.2 First case: only one party refers to its general conditions

When a seller makes a contract proposal which includes his general conditions of sale and the purchaser accepts such proposal, there are no particular problems, as in the following example.

According to generally recognized principles on the formation of contract (supra, § 6.6.1 and 6.6.2), there should be no doubt that, since the buyer has accepted the seller’s proposal without any reservation, the parties have concluded a contract of sale, which includes the conditions expressly negotiated between them as well as the general conditions of the seller. Thus, if a dispute arises at a later stage, the general conditions in question will apply.

Let us now imagine a slightly different situation, where the buyer makes the final proposal:

In this second case, the seller’s “acceptance” contains additional terms, since the seller added his general conditions.

We can reasonably assume that such additional terms materially alter the contract terms contained in the offer made by the purchaser. In fact, general conditions of sale are drafted with the aim of favouring the seller, and they always contain terms which derogate the otherwise applicable rules to the advantage of the seller (e.g. by limiting the seller’s liability in case of delayed delivery and in case the goods are defective, or by specifying jurisdiction by the seller’s courts).

Consequently, the seller’s “acceptance” must be considered as a counter-offer, even when rules which admit an acceptance with modifications are applicable (see, above, § 6.6.1-6.6.2), since there can be no doubt that the additional terms contained in the general conditions imply a material alteration of the offer.

If the buyer thereafter performs the contract of sale without objecting to the inclusion of the general conditions (e.g. by issuing a documentary credit or by taking delivery of the goods), this will amount to a tacit acceptance of the counter-offer and, consequently, the general conditions of the seller.

However, one very important point should be mentioned in this context. Since the (written) acceptance is to be considered as a counter-offer, the real acceptance, in the form of conduct indicating assent, cannot be considered as an acceptance “in writing”.⁵³

This is particularly important for clauses which need to be agreed in writing, such as choice of forum or arbitration clauses, which, in most jurisdictions, require written acceptance to be valid.

Thus, in the case examined in example 6-11, the general conditions of the seller will apply, but the clause providing for the exclusive jurisdiction of the courts of the seller’s place of business, contained in the general conditions, will not be effective unless the applicable law considers oral choice of forum as valid, which is rather unlikely.

6.6.3.3 Second case: both parties refer to their general conditions

The situation becomes more complicated when both parties try to incorporate their general conditions into the contract. In this situation, also called battle of the forms, both parties use forms that incorporate their respective general conditions when concluding sales contracts.

It is consequently essential for the buyer to know, even if he does not want to bring a claim before a court but simply to negotiate a settlement, which rules are to be applied. If his conditions of purchase apply, he will be entitled to recover the damage (provided he can prove the existence of the defects, of course); on the contrary, if the seller’s conditions apply, he will have no claim against the seller, since the six-month term for notifying the defects has elapsed and, in any case, the right to claim damages is expressly excluded.

If we simply apply the traditional rules on the conclusion of contracts examined in paragraphs 6.6.1-6.6.2, and especially the “mirror image rule”, the general conditions of the buyer will apply. In fact, the “acceptance” by the buyer, which does not conform to the seller’s “order confirmation” (since it adds the buyer’s conditions of purchase, which materially alter the terms of the contract proposal made by the seller), is a counterproposal that has been accepted by the seller, whose conduct (shipping of the goods) implies acceptance of such counterproposal.

This conclusion, which is the logical consequence of the application of the “mirror image rule”, also called “last shot rule” because it favours the party that makes the last proposal based on its general conditions, is not very satisfactory.

Since the parties are normally not aware of this mechanism, the final result is that the application of the general conditions of one or the other party is merely accidental and does not express a deliberate will of the parties.

This is why in some legal systems alternative solutions have been established, which come closer to the expectations of the parties. One is the “knock out doctrine” according to which, when both parties refer to their respective general conditions, none of these conditions apply (or only those provisions which are not contradictory).⁵⁴

In practice, considering the large number of countries having ratified the Vienna Convention of 1980 (CISG), in most cases the issue will have to be dealt with under Article 19 of the Convention.

Since Article 19 implies a rather strict application of the mirror image rule (supra, § 6.6.2), it can be said, in general terms, that under the UN Convention, the “last shot rule” will apply in case of a battle of the forms.

However, there is also case law, especially in Germany,⁵⁵ that applies the so called “knock-out doctrine” and comes to the conclusion that conflicting standard forms are completely invalid and are replaced by CISG conditions, while the contract as such stays valid.

A similar approach has been taken in the UNIDROIT Principles, which contain a special rule on this issue.

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UNIDROIT Principles – Article 2.1.22 - Battle of forms

Where both parties use standard terms and reach agreement except on those terms, a contract is concluded on the basis of the agreed terms and of any standard terms which are common in substance unless one party clearly indicates in advance, or later and without undue delay informs the other party, that it does not intend to be bound by such a contract.

However, as discussed above in § 6.6.2, it is unlikely that the UNIDROIT Principles can be applied to the formation of contracts that incorporate them by reference, which means that they will come into consideration only where their application has been agreed before negotiating the contract or where they are applied as part of the lex mercatoria.

6.6.3.4 Advice to negotiators

Where parties decide to make use of general conditions of contract, they should take the necessary steps to make sure they will actually become part of the contracts they are concluding.

In theory, the simplest way to reach this result is to request that the other party return a signed copy of a proposal containing such general conditions, e.g. a confirmation of order. In practice, however, this is difficult to obtain. If the other party is not willing to return a signed copy as requested, most companies will nevertheless complete the deal rather than risking the loss of a customer. Only sellers or buyers that have strong bargaining power will be able to impose the written acceptance of their general conditions upon the other party.

We can therefore assume that in most cases the party that has drafted general conditions of sale or purchase must expect that its counterparts will not expressly agree to such conditions, or may even try to impose their own conditions. Where this is the case, the only possible strategy is to attempt to always have the last word, by including a reference to its own conditions in all documents sent to other parties.⁵⁶ This strategy, which may be effective in jurisdictions that apply the so-called “last shot doctrine”, offers no certainty, but it may be a reasonable compromise solution for parties not having enough bargaining power to obtain the express acceptance of their own conditions.

Another possibility is to take advantage of a situation in which one party may succeed in having the other party accept its general conditions for future deals. Thus, in the context of contracts that will give rise to a series of future contracts of sale, such as a distribution or a franchising agreement, it is possible to include a clause whereby future contracts of sale will be governed by the general conditions of one of the parties. A further option, which may be used when selling through commercial agents, is to put the general conditions in the order form that the customer is asked to sign,⁵⁷ but here too the problem is that most customers will not be willing to sign the order form.

6.6.4 Effectiveness of clauses contained in general conditions

One other important issue which arises in the context of general conditions is the need to protect the party that accepts, normally without negotiating them, terms previously drafted by the other party.

In this field, possible rules protecting consumers against abusive clauses contained in general conditions (in force in the countries of the European Union as a result of EC directive 93/13) play a very important role. Under such rules, many types of clauses are simply null and void when contained in general conditions used in consumer contracts.[Page149:]In principle, these rules are not relevant in the context of this book, which only deals with B2B contracts. However, in some jurisdictions rules protecting consumers also apply, although to a lesser extent, to contracts between business people.

One possible means of protection for the weaker party is to state that certain more dangerous clauses contained in general conditions proposed by one party are only effective if they have been expressly accepted by the other party.

An interesting example of this type of approach is contained in Article 2.1.20 of the UNIDROIT Principles

UNIDROIT Principles – Article 2.1.20 - Surprising terms

1. No term contained in standard terms⁵⁸which is of such a character that the other party could not reasonably have expected it, is effective unless it has been expressly accepted by that party.
2. In determining whether a term is of such a character regard shall be had to its content, language and presentation.

In practice, this solution is not without danger for parties using general conditions, given that, on the one hand, it may not be easy to decide which terms can be considered as surprising and that, on the other, the “remedy”, i.e. the express acceptance, is not at all clear. Will it be sufficient to request that the accepting party sign a declaration saying that it accepts all the terms contained in the general conditions? Or should the declaration expressly indicate the surprising terms?⁵⁹ Or should there be evidence that the party in question has actually read the terms before accepting them?

Considering all of these uncertainties, the risk of possible abuses by the “weaker” party are, in our opinion, too great, and this type of approach appears to be inappropriate to govern B2B relations. This is why it is recommended to strike Article 2.1.20 when incorporating the UNIDROIT Principles (supra, § 2.8.2.3).

6.6.5 Clauses governing the entry into force of the contract

Normally, the contract enters into force when it is concluded, i.e. when it is signed by both parties or agreed orally. Where the contract is agreed through a written exchange, the time of conclusion may be different according to the applicable law. In many legal systems, the contract is deemed to be concluded when the acceptance reaches the offeror60 or becomes known to the offeror; in some others, it is already concluded when the acceptance is sent to the offeror.⁶¹

In order to avoid possible uncertainties, the parties may try to expressly agree upon rules governing the contract conclusion, but in order to be effective such rules should be agreed before negotiating the contract. Thus, one should bear in mind that a relatively common practice, consisting of the inclusion of rules of this type in the general conditions (like the clause whereby the offeree is deemed to have accepted the offer if he does not answer within a certain time), will not be effective unless the parties have agreed in advance that these rules should be applied to future dealings between them.⁶²

A more frequent situation occurs when the parties sign the contract, but wish to postpone its entry into force until a later point in time when certain conditions will have been met. Thus, they may agree that the contract will not enter into force until certain[Page150:]government authorizations have been granted, or until a party has fulfilled certain preliminary obligations (e.g. advance payment, issuance of a documentary credit or a bank guarantee).

In most legal systems, clauses of this type would be construed as conditions. However, this may give rise to problems for several reasons.

First, if a condition is still to occur, the contract should, in principle, not produce its effects. One could consequently argue that the parties are not under a contractual obligation to take the necessary steps for the event to happen.

Second, in many jurisdictions if the event upon which the entry into force is conditional merely depends upon the discretion of a party, it would not be considered as a valid condition.

Considering all of this, it may be preferable not to make the entry into force of the contract as a whole conditional upon certain events, but simply to state that until certain conditions are met, the performance of the basic obligations under the contract will not begin. An example of this type of approach can be found in Article 3 of the ICC Model Contract for the Turnkey Supply of an Industrial Plant,⁶³ which makes a distinction between the entry into force of the contract and the “commencement date”.

ICC Model Contract for the Turnkey Supply of an Industrial Plant - Article 3 - Entry into force of the Contract

3.1 Entry into force. This Contract shall enter into force on the date of signature by both Parties.

The Parties will undertake all necessary steps for facilitating the occurrence of the events indicated in Article 3.2.

3.2 Commencement Date. The obligations to perform the work contemplated by this Contract shall commence on the date on which the latest of the events listed in Contract Schedule B has occurred (the Commencement Date). If no event has been listed in Contract Schedule B, the Contract obligations shall commence on the date of signature of this Contract.

3.3 Non-occurrence of the Commencement Date. If the Commencement Date has not occurred, according to Article 3.2, within six months from the date of signature (or within such other term as may be agreed between the parties: see Contract Schedule C), either Party may terminate the Contract by written communication to the other Party.

In the context of a clause of this type, there will be no doubt that if a party does not perform those obligations it has to fulfil before the commencement date (for example, the obligation to provide a bank guarantee), this will be considered as a breach of the contract (which is in force from its signature), and consequently the other party can bring, or at least threaten to bring, a claim against it under the contract.

Another important point, expressly dealt with in the above clause, is to make sure that, if the conditions for the entry into force do not occur within a certain time limit, the contract can be terminated, and the parties can look for other partners.

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