Contract

From Max-EuP 2012

by Hannes Unberath

1. Subject matter of the law of contract, contractual obligation

Contracts permit voluntary transfers of all types of performances among unrelated parties and, together with the private ownership of property, are a hallmark of free-market legal systems. The supreme principle of contract law is that contracts must be performed: pacta sunt servanda. On formation of a contract (contract (formation)), the debtor assumes a duty to perform, which corresponds to the creditor’s right to demand performance. If the parties were not bound to perform, the ‘contract’ would be nothing more than a declaration of intent. Failure to perform would then justify compensation merely for the reliance interest. Such a limited view of contractual liability strongly influenced contract theory in the 20th century (Lon Fuller, Patrick Atiyah, Grant Gilmore). In contrast, all European legal systems proceed from the obligatory nature of contract and seek to protect the creditor’s interest in performance (Art 9:101, 9:102, 9:502 Principles of European Contract Law (PECL); Art III.-3:301, III.-3:302, III.-3:702 Draft Common Frame of Reference (DCFR) (Common Frame of Reference (CFR)); see also Inst. 3, 13). Scholars give a variety of reasons for why a contract is binding: for Immanuel Kant, who influenced particularly Friedrich Carl von Savigny, the contract is an a priori form of action whose content the parties can determine and for which they are responsible; in France, Robert Joseph Pothier developed a similarly strong orientation toward personal autonomy. In contrast, teleological theories see a party’s intention as decisive for the validity of a contract only to the extent it is aimed at a purpose worthy of recognition: contracts must be proper, and thus fair (see, more recently, James Gordley, who proceeds from the precepts of scholastic jurisprudence). In addition, since the time of John Stuart Mill one finds consequentialist/utilitarian theories which have been influential beyond the Anglo-American world. These theories justify contractual obligation instrumentally as being socially efficient.

The purpose of contract law is to enforce contracts. A court must thus be convinced that the contract is valid and take measures to protect the rights flowing from that contract. Accordingly, contract law must provide answers to the following three questions, the solutions to which diverge considerably among legal systems: (i) Which rules apply to contract formation and determine its content? (ii) What limits should be imposed on the contract? (iii) How should one respond to breaches of contract?

2. Tendencies of legal development, uniform law

Contract law as a systematic network of general rules developed gradually at first, guided primarily by the efforts made towards universalization in the natural law theory of the Enlightenment. Both on the European continent and in England, contract law consisted for some time only of individual actionable forms of contract (the actiones of Roman law, the forms of action in England). Not until relatively late did the principle of private autonomy (freedom of contract) lead lawyers to conclude that the contracting parties’ agreement was not only a necessary, but also a sufficient condition to establish a coercive right: in France this culturally decisive achievement was attained with the Code civil (Art 1101 and Art 1134); England did not take this step until the second half of the 19th century, acting under the influence of continental thought. Germany followed with the Bürgerliches Gesetzbuch (BGB) of 1896, which had been influenced accordingly by the historical school. Roman law exercised a particularly strong influence on the theory of responsibility (culpa) and the structure of the specific part of contract law in the continental European tradition. English law of the 19th and 20th centuries received impulses primarily from commercial law and established a general law of contract which survives with far fewer, yet abstracter and more far-reaching principles; for breach of contract, English law responds with strict liability and the prevalence of damage awards, thus primarily satisfying the needs of commercial trade.

In respect of uniform law, the CISG (sale of goods, international (uniform law)) is warranting emphasis, with over seventy signatory states. In addition to international conventions for specific areas, the non-binding Incoterms, formulated by the International Chamber of Commerce (ICC) in Paris, are of practical importance. At the European level, the fundamental freedoms of the EU Treaty have led to the dismantling of trade barriers. Within the last thirty years, contract law has increasingly become the object of secondary EU law. The main concern of most legal provisions is consumer protection (consumers and consumer protection law). Aspects of general contract law (information obligations (consumer contracts), right of withdrawal and return of goods, standard contract terms) as well as specific types of contracts are thus regulated uniformly. The associated and significant interventions—particularly in the case of the directive on the sale of consumer goods (Dir 1999/44)—into the legal systems of the EU Member States have resulted in a comprehensive reform of the German law of obligations and in an even more far reaching reform project in France. Other contractual aspects have also been regulated (such as form, E-Commerce Directive (Dir 2000/31), and liability, directive combating late payment in commercial transactions (Dir 2000/35)). The hypertrophy in isolated interventions without any comprehensive concept has led to criticism and is currently the topic of comprehensive reform considerations (DCFR). The Principles of European Contract Law (PECL), developed by the so-called ‘Lando Commission’, pursue a basically different approach, namely one of systematic restatements, based on comparative research. Like the UNIDROIT Principles of International Commercial Contracts (PICC), the PECL are influenced by the CISG. The Draft Common Frame of Reference (DCFR) builds on the PECL.

3. Contract formation and content

Contractual duties arise from the corresponding intention of the contracting parties (meeting of the minds). Legal duties, however, may arise only to the extent that a third party—the court—can assign external processes to the parties as declarations of their intention. Whether the court should base this attribution primarily on external (objective) elements of the declaration (‘declaration theory’) or on internal (subjective) circumstances (‘will theory’) and how the court should proceed when the external act of declaration deviates from the subjective intention are two of the most debated problems of contract law. Basically, European legal systems emphasize an individual’s responsibility for the cognizable effect of his actions in legal transactions and essentially follow an objective approach (cf Art 2:102 PECL, Art II.-4:102 DCFR).

The legal systems significantly diverge regarding the relevance of a lack of intention, particularly for mistake. The attitude that generally only mistakes regarding the nature of the legal transaction are legally relevant stems from Roman law. On that basis, Friedrich Carl von Savigny developed a theory differentiating between a mistake that significantly affects the voluntariness of the act of declaration and a basically irrelevant mistake in motivation (mistake of motive). This distinction had an influence particularly on German law. Rudolph von Jhering emphasized the existence of duties relating to the formation of contract, which the BGB initially regulated only partially. German law takes account of unilateral mistakes relating to the content of a declaration as a basis for avoidance even if the other contracting party was not responsible for the mistake (§ 119 BGB); the BGB, however, has some difficulty in rationalizing a claim for damages when the other party is responsible for inducing the mistake even in cases of negligence (culpa in contrahendo). In contrast, misrepresentation seems to be adequately dealt with in English law, while its rules on mistake have also met with some criticism. Arts 4:103, 4:104 PECL (and see Art II.-7:201, II.-7:202 DCFR) combine the factors one finds in the individual legal systems and emphasize objective criteria of legal certainty and responsibility, so that for a ‘mistake in communication’, the determination will depend also on whether the mistake is ‘excusable’. One hardly finds divergences in the national treatment of intentional misrepresentation (fraud) and duress, even though, of course, the application of these rules in the individual cases can be difficult (Arts 4:107, 4:108 PECL; Arts II.-7:205, II.-7:206 DCFR). In contrast, interferences with a party’s freedom falling below this threshold but leading to a contract disadvantageous for one party (‘distorted contractual parity’, undue influence) are evaluated differently.

Rules on whether agreement was reached (contract (formation)) also diverge in their details. In particular, the revocability of an offer is seen differently (binding nature of the offer under German law versus mailbox rule under English law); Art 16 CISG and Art 2:202 PECL seek a compromise. Differences regarding other requirements of formation, such as form or consideration (indicia of seriousness), are of both theoretical and practical interest. From the viewpoint of a purely implemented will theory, these limitations appear anomalous, but as a reaction to the inherent human imprecision associated with the formation of intent they are pervasive. Form requirements, such as those often imposed for gratuitous or dangerous agreements, are admonitory in nature and provide evidentiary benefits. Doctrinally difficult to classify are the requirements of consideration under English law and of cause under French law. While the former requires an exchange of performances for an agreement not embodied in a deed to be valid, French law recognizes the provision of security and gratuitous performances as valid contractual goals. The PECL’s omission of similar requirements is an unproblematic simplifica-*tion.

In German law the obligatory agreement (Schuldvertrag) does not effectuate the transfer of property. A separate agreement (dinglicher Vertrag) must be concluded for the transfer of property. The obligatory agreement is solely the underlying reason for the separate and, as to its validity, independent transfer agreement (so-called ‘separation and abstraction principles’ (Trennungs- und Abstraktionsprinzip)). This approach, unique in Europe, is claimed to have analytic advantages. In general it tends to increase legal certainty in relation to transfers of title.

The legitimating force of the contracting parties’ consensus can be effective only inter partes, with the result that the contractual relationship is relative. Still, there are exceptions, already recognized by Roman law. In contrast, the consideration doctrine in England led to unsatisfactory results, which the legislature did not correct until 1999. Although in a contract in favour of a third party, the third party is not consistently treated as a party to the contract, he nonetheless receives protection against subsequent alteration of the contract, and performance may not be forced upon him (Art 6:110 PECL, Art II.-9:303 DCFR). Under German law, which is marked by a particularly restrictive law of delict (law of torts/delict, general and lex Aquilia), contractual duties of care are extended to non-contracting parties, as far as they are included in the protective scope of the contract (contract with protective effect for third parties). In contrast, the liability of experts for providing incorrect information is increasingly based on culpa in contrahendo (§ 311(3) BGB).

Judicial determination of the content of the contract necessarily precedes contract enforcement. Whether one should in the interpretation of contracts consider the objectively cognizable or the subjectively intended is not uniformly answered throughout Europe. In general, a trend towards the ‘objective method’ is noticeable (Art 5:101 PECL, Art II.-8:101 DCFR). English law takes an approach more oriented towards the wording of the contract, yet still gives preference to the parties’ corresponding intentions over what they have falsely declared (falsa demonstratio non nocet). The question to which extent one may rely on circumstances beyond the wording of the contract is not uniformly answered, but the restrictive parol evidence rule has been increasingly suppressed in England; the Principles of European Contract Law (PECL) do not adopt this rule (Art 5:102).

If the contracting parties had unlimited resources and information would be equally available to them, they would form a Pareto optimal ‘complete’ contract that corresponded to their preferences. As economic analyses of law and legal practice reveal, however, contracting parties never have unlimited resources and equal information available. The parties’ declarations are instead incomplete and self-contradicting, but these defects do not necessarily affect performance of the contract. The segmentary articulation of the parties’ intentions impedes determining the duties of performance (performance and its modalities). As a result, subtle mechanisms for supplementing the actual terms of the contract have been developed. They include gap filling through ‘supplementary interpretation’ (interpretation of contracts). Default rules, or implied terms are also available which attempt to capture the parties’ presumed intentions in typical situations. They apply unless the parties derogate from them, thus reducing the transaction costs inherent in the formation of contracts. Codified legal systems provide for various contractual models more intensively than the common law, which in turn pays more attention to the details of the particular case and forces the parties to agree upon detailed contractual texts. The borderlines between the supplementary mechanisms are fluid: in Germany, for example, where the establishment of default rules is primarily the responsibility of the legislature, the courts also employ supplementary contract interpretation in connection with the principle of good faith. Exceptionally, unanticipated disturbances of performance may justify adapting the contract (change of circumstances). Standard terms are another mechanism for supplementing the individually negotiated contract terms.

4. Limitations of contract law

An essential characteristic of a contract is that one party freely binds himself towards another to perform or refrain from performing an act (see, for example, ECJ Case C-334/00 – Tacconi [2002] ECR I-7357). Consequently, legal subjects select their contracting partner and determine the content of their performance (freedom of contract). All European legal systems, however, refuse to recognize contracts that pursue unconscionable goals, in part because they violate a legal prohibition (illegality) or are contrary to public policy (illegality of contracts). Conflict of laws (private international law (PIL)) provides for a reservation reduced to the basic content of ordre public.

Furthermore, legal systems partially determine the content of a contract through mandatory law; also, sometimes, they coerce a party to conclude a contract. Such limitations of contractual freedom vary among legal systems and typically apply to monopolistic structures, or in situations where it can be assumed that particular market participants require special protection, such as in the fields of labour law, landlord-tenant law, or consumer protection. Traditionally there were hardly any mandatory rules of uniform law (see, for example, Art 4:101 PECL); however, at the European level the limits of freedom of contract have been increasingly uniformly regulated (discrimination (contract law), consumers and consumer protection law).

5. Breach of contract

On concluding a contract, the debtor is obliged to perform vis-à-vis the creditor. If the debtor fails to perform, a legal system must provide the creditor with a mechanism to protect his performance interest in accordance with the basic principle of pacta sunt servanda. Essentially three reactions to a failure to perform are conceivable: specific performance (primary obligation), compensation in the form of a monetary claim damages (secondary obligation), and the termination of the parties’ duties to perform (termination of a contract).

Difficulties arise with specific performance when the duty to perform does not consist in the payment of money. Whereas on the European continent the creditor can generally request fulfilment in natura (a common exception being instances of impossibility), specific performance under English law is only allowed exceptionally. Still, in actual practice there is a considerable convergence of results, be it because the coercion to perform is not sufficiently strongly entrenched to be practically attractive (eg for a duty to deliver goods in kind in § 894 ZPO), or be it because English law allows specific performance when damages in money do not adequately protect the creditor’s interest in performance (eg for so-called unique goods, particularly land). While Art 28 CISG solves the problem by a conflict of laws provision, the PECL, UNIDROIT PICC and the DCFR essentially support specific performance, even though its efficiency is debated. Differences also exist regarding the question whether, in the interest of maintaining the primary obligations, the creditor has to allow the debtor to perform in natura before he turns to damages in money (see, for example, German and French law, whereas this hierarchy is alien to English law; the CISG again takes a middle position).

If the debtor breaches the contract, then damages in money can in principle place the creditor in the position he would have been in had the debtor duly performed. European legal systems basically protect the expectation interest (Art 9:502 PECL). The secondary obligation to pay damages presupposes that the debtor was responsible for breaching his primary obligation to perform, which under continental European law usually requires ‘fault’ (faute, fault, culpa). The standard of liability varies: for result-oriented obligations (obligation de résultat), English and French law—followed by the CISG, PECL, and the DCFR—basically recognize only the defence of unavoidable force (frustration, force majeure). German law, by contrast, always applies the principle of fault embodied in § 276 BGB, even for result-oriented obligations. Still, in Germany an objective standard of diligentia is applicable, which also favours strict liability (eg for the financial means necessary to perform, or the risk associated with obtaining goods for an obligation in kind). Differences exist regarding the relevance of a mistake, eg the liability for consequential loss flowing from non-conformity. Whereas a seller under German law is not liable for consequential loss based on a defect that he could not recognize, the CISG imposes strict liability. Otherwise, and particularly concerning a defective performance that may be cured, the differences between the legal regimes disappear. The remedy of price reduction, deriving from Roman law, also essentially allows a party to claim the reduction in the value of goods or of a work produced resulting from a defect without any recourse to fault. But this remedy is not available for all types of contract (eg service contracts). For duties of performance that, in light of their nature, only require undertaking an activity lege artis (obligation de moyens), one hardly finds any differences because here also English and French law reduce the standard of liability to one of objective care. Liability is imposed for damage that is caused by breach of contract to the extent that it was foreseeable and/or covered by the protective purpose of the duty violated (causation). Compensation for frustrated expenses incurred in reliance on the expected performance is sometimes allowed as an alternative (eg § 284 BGB). Punitive damages for a breach of contract and disgorgement of the debtor’s gains from a breach (so-called efficient breach) are controversial across the legal systems and awarded only in exceptional cases.

The secondary obligation transforms the debtor’s duty to perform his side of the bargain into a duty to pay, but it does not affect the creditor’s duty to perform. Termination extinguishes the mutual duties to perform and leads to restitution if performance has already been rendered, eg § 346 BGB (unwinding of contracts). Termination for breach of contract accounts for the fact that the secondary claim often cannot protect the creditor’s interest in performance sufficiently (eg in cases in which the debtor is not responsible for the breach, or where damages are inadequate). Exactly when the interest in performance is endangered is regulated differently. The CISG requires a fundamental breach, German law essentially requires the fixing of an additional period for performance (Nachfrist). French law even reserves termination to the courts if nothing contrary was agreed upon by the parties, as is, however, often the case (by means of so-called clauses résolutoires) (Art 1184 Code civil). English law looks at the parties’ intention, which, although a plausible approach, leads to uncertainty in the individual case. For obligations extending over a period of time, termination is generally limited to the future and additionally fulfils the function of releasing the parties from an obligation incurred over an unspecified period of time.

Literature

Reinhard Zimmermann, The Law of Obligations (1996); Tony Weir (tr), Hein Kötz, European Contract Law, vol I (1997); Stephan Lorenz, Der Schutz vor dem unerwünschten Vertrag (1997); David Ibbetson, A Historical Introduction to the Law of Obligations (1999); Hugh Beale, Arthur S Hartkamp, Hein Kötz and Dennis Tallon (eds), Cases, Materials and Text on Contract Law (2002); Stephen Smith, Contract Theory (2004); Sir Basil Markesinis, Hannes Unberath and Angus Johnston, The German Law of Contract (2nd edn, 2006); Hannes Unberath, Die Vertragsverletzung (2007); Alan Farnsworth, ‘Comparative Contract Law’ in Mathias Reimann and Reinhard Zimmermann (eds), The Oxford Handbook of Comparative Law (2008) Edwin Peel, Treitel on the Law of Contract (13th edn, 2011).

Retrieved from Contract – Max-EuP 2012 on 24 September 2022.

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