Contractual Terms, Subsequent Determination

From Max-EuP 2012

by Jens Kleinschmidt

1. Definiteness of contractual content and subsequent determination of contractual terms

a) Regulatory context

It is accepted everywhere that the content of any contract has to be ‘definite’, ie it must be determined or at least determinable. An ‘indefinite’ contractual obligation could neither be sued upon nor enforced by execution measures. Legal systems of a Romanistic tradition often express this principle as the requirement of a determined or determinable ‘object’ of the contract (objet, oggetto, objeto), in the absence of which no valid contract is formed. Quite frequently, however, parties conclude contracts that do not address all relevant points. It is then for the rules on the formation of contracts (contract (formation)) to decide whether a valid contract has come into existence. If parties have begun to perform, this is a strong indication of their intention to be bound. Gaps may then be filled by implying terms derived from statute or other rules of law (default rules, ius dispositivum), from trade usage or from prior practices between the parties. More problematic are cases where not only peripheral points but a principal obligation, in particular the price, has—consciously or unconsciously—been left indefinite. In many legal systems (eg England, France, Germany, Italy, the Netherlands, Switzerland), the legislature and the courts help the parties—at least concerning certain types of contract—by upholding the agreement and supplying a price by referring to the market price, the price generally charged by the contract partner, or a reasonable price. In Germany, the creditor generally has the right unilaterally to fix the price if nothing has been said about it (§ 316 Bürgerliches Gesetzbuch (BGB)). The European and international model rules (Principles of European Contract Law (PECL); UNIDROIT Principles of International Commercial Contracts (PICC); Draft Common Frame of Reference (DCFR)) provide rules for all contracts where the parties have not fixed or agreed on a mechanism for determining the price. According to Art 6:104 PECL, the parties are to be treated as having agreed on a reasonable price. Article 5.1.7(1) UNIDROIT PICC and, though in different words, Art II.-9:104 DCFR primarily refer to ‘the price generally charged at the time of the conclusion of the contract for such performance in comparable circumstances in the trade concerned and, if no such price is available, to a reasonable price’.

b) Purpose of a subsequent determination and basic problem

The contract itself may provide for a mechanism to fill contractual gaps deliberately left open by the parties. The parties may agree that the term left open is to be determined by one of them or by a third party. Although it may prima facie appear as if the parties renounce their private autonomy by such a delegation, they in fact exercise it. Depending on who is given the right of subsequent determination, such a mechanism can serve various purposes. Delegating the decision to a neutral expert may help overcome disagreement or make up for a lack of expertise. By granting a party the right to subsequent determination, the parties often intend to facilitate the performance of a contract when the exact content of the contractual obligations cannot be determined at the time of its conclusion because that would be too costly or time-consuming, because it would require additional information, or because performance is only to take place at some point in the future. A special case of subsequent determination by a party is presented by contract clauses that grant one party the right to charge whatever its list price may be on the day of performance. Such a right of subsequent determination may therefore also serve as a protection against market fluctuations. Parties may not only provide for a right of subsequent determination in order to render their agreement complete, but also as a mechanism to adjust a complete and binding agreement to a change of circumstances. This becomes relevant mostly in the case of long-term contracts or recurring obligations.

Every legal system has to decide whether it regards the parties’ agreement on such a mechanism as sufficient for the content of the contract to be determinable, and the contract to be valid at the time when it is entered into. That decision, on the one hand, has far-reaching consequences if one of the parties begins to perform in reliance on the validity of the transaction. On the other hand, the legal system must not encourage opportunistic behaviour by enabling a party to invoke the incompleteness of the contract and thus to withdraw from a transaction that both parties had considered as binding. If difficulties occur in the process of subsequent determination, another fundamental question arises: what is the proper role of the courts in the parties’ contractual relations? In other words, to what extent should courts be allowed to ‘save’ a contract by filling contractual gaps? Especially from an economic perspective, criticism has been voiced against too sweeping judicial intervention under the auspices of ‘reasonableness’.

Subsequent determination of contractual terms is mostly discussed with regard to the fixing of the purchase price. But the same problems arise with regard to other elements of the contract albeit not with the same vigour in the case of more peripheral matters where default rules or implied terms are available for gap-filling (performance and its modalities). It is also for historical reasons that the discussion has concentrated on the fixing of the purchase price. Roman sales law contained a requirement of pretium certum. This requirement did not imply that an actual figure had to be agreed upon, but the purchase price had to be objectively ascertainable even if it was yet unknown to the parties. Moreover, the price could also be fixed by a third party. This had been disputed in classical law, but Justinian settled the question by regarding the contract as a valid sale concluded under a suspensive condition: it is to become effective only if the third party actually fixes the price (C. 4,38,15). A contracting party itself, on the other hand, could not be given the power to fix the price unilaterally. The unilateral determination of the price would have removed the important safeguard against a contractual imbalance afforded by the process of negotiating the contract. Moreover, pretium certum indicated when the sale became ‘perfect’ which, in turn, was significant for the transfer of risk. For transactions other than sale and locatio conductio, the requirement of pretium certum did not exist to the same extent.

c) Delimitations

The precise content of performance is determined only at a later stage also in the case of alternative obligations, or obligations concerning generic goods. Performance is determinable from the outset in the case of index or price fluctuation clauses, which link the contract price to an objectively certain market price, index, or other parameter and are thus intended to protect the creditor against fluctuations in the market. Some legal systems (eg France, Germany) restrict the use of such clauses in order to avoid adverse effects on inflation. If the factor referred to in the clause ceases to exist, the nearest equivalent factor will be used as a substitute in order to capture what the parties will most likely have intended (this is—albeit with different justifications—the approach in many national legal systems as well as in Art 6:107 PECL, Art II.-9:107 DCFR and Art 5.1.7(4) UNIDROIT PICC).

2. Subsequent determination by a third party

Under all contract law systems in Europe, it is possible to delegate the subsequent determination of contractual terms to a third party. Not all legal systems, however, contain general provisions to this effect (but see Germany, Italy, the Netherlands). In some countries, this rule is only spelt out in the context of specific types of contract, and particularly in the context of determination of the purchase price (eg Austria, Belgium, England, France, Spain). The contract is concluded in two stages. First, the parties agree to delegate the determination of certain points to a third party, and then the third party actually makes its determination. In practice, a second contract addressing issues such as remuneration and liability will bind the third party to the parties or at least to one of them.

a) Regulatory problems and solutions in the national legal systems

Two main issues need to be regulated: the procedure and the review of the determination. The parties may choose the third party themselves or delegate the selection to, eg, an expert organization. In England, France and the Netherlands, a determination by a third party that is not impartial is not binding. In Germany even a third party that is closer to one of the parties can make a valid determination (though this cannot be agreed upon by standard contract terms); German courts consider the subsequent judicial review of the determination as a sufficient safeguard against partiality. It is up to the parties to define the standard by which the third party must abide in making its determination. Many legal systems distinguish between reasonable (equitable) and unfettered (absolute) discretion (billiges Ermessen as opposed to freies Belieben). This distinction goes back to the juxtaposition of arbitrium boni viri and arbitrium merum in the ius commune. Unless it is otherwise agreed, the standard is reasonable discretion in Belgium, Germany and Italy, ie the determination has to be made in an equitable manner. French law, by contrast, is somewhat more liberal towards the third party by conceptualizing him as the joint agent (mandataire commun) of the parties. Fundamental differences exist between the national approaches if the third party cannot or will not make the determination and if therefore a contractual term remains open—unless, of course, the parties find an autonomous solution. Some legal systems (eg Austria, Spain; and generally also France) follow the approach prevailing in Roman law and regard the contract as invalid. Others (eg Germany, Italy, the Netherlands, generally also England, but not concerning the sale of goods) leave it to the courts to save the contract and make the necessary determination. If, however, an interpretation of the contract reveals that the parties sought a determination by a particular third party named in the contract (intuitu personae), the contract will be void failing a valid determination. This will especially be the case if the parties have put very high trust in the third party by leaving the determination to its complete, unfettered discretion; in this case, a court would lack an objective standard for making the determination. As an alternative, the court can be empowered not to make the determination, but to replace the third party—at least if the parties did not seek a determination by a particular third party (Belgium, for the determination of the purchase price also Italy). This solution leaves the determination as much as possible out of the courtroom and in the hands of private parties, but it can lead to a considerable prolongation of the whole procedure.

At least in principle, any determination by a third party may be challenged before a court. However, the standard to be applied by the court for reviewing the determination does not necessarily coincide with the standard by which the third party was to make the determination. Where the third party had to make the determination according to its reasonable discretion, ie in an equitable manner, in many countries a court may only declare the determination non-binding if it is manifestly unreasonable or inequitable (Austria, Belgium, Germany, Italy, Spain, onaanvaardbar in the Netherlands, erreur grossière in France). This criterion is obviously based on Roman law (manifesta iniquitas). It prevents the judge from replacing the decision of a third party, chosen for its expertise, with his own decision. Where the determination was to be made according to the unfettered discretion of the third party, it can only be challenged if it is illegal or against public policy (Germany) or if it was made in bad faith (Belgium, Italy, Spain). Differing attitudes towards the proper role of the judge become apparent from the answers to the question of which consequences should flow from a successful challenge of the determination. While, for example, French law generally regards the contract as void, subject to a new determination, judges in Austria, Germany, Italy or the Netherlands may take over the position of the third party and make the determination themselves in order to save the contract. In doing so, the judge will most probably rely on the opinion of a court-appointed expert where the determination concerns difficult valuations or technical matters. Appointing a new third party would therefore only constitute an unnecessary complication compared to such judicial substitution. Judicial substitution is excluded, though, where the parties had agreed to leave the determination to the unfettered discretion of the third party. English courts are reluctant to interfere with the determination of the third party. They prefer to refer the parties to liability claims against the third party.

Determination of a contractual term by a third party has to be distinguished from several other phenomena: (i) Instead of completing or adjusting a contract, a third party is often entrusted with the task of fixing or clarifying certain facts that are relevant for the parties’ transaction (eg assessment of the quality of performance). In many legal systems, the rules on the subsequent determination of contractual terms by a third party are also applied mutatis mutandis to these kinds of cases. Other legal systems have developed separate rules. The borderline between both sets of cases will often be blurred, and they are sometimes subsumed under a common heading (‘expert determination’, Schiedsgutachten). (ii) The binding determination by a third party also has to be distinguished from non-binding decisions or proposals by a third party, as they can be found, for instance, in the context of mediation. (iii) In many legal systems (eg England, Germany, the Netherlands, Sweden) the parties may also ask an arbitral tribunal to make the determination. A clear distinction between both mechanisms proves to be difficult, especially where the task of the third party is that of a factual assessment. The criterion applied in many legal systems (eg France, Italy)—arbitration for the settlement of a ‘dispute’, expert determination for supplementing a contract—often does not prove to be helpful in practice, so that the question is ultimately left to an interpretation of the parties’ intentions. The similarity of both mechanisms has led many authors to suggest a (partial) application of the rules developed for arbitration procedures to expert determinations.

b) Approaches in the European and international model rules

The European and international model rules only contain fragmentary regulations on the subsequent determination of contractual terms by a third party. Relevant rules can be found in Art 6:106 PECL, which is in substance followed by Art II.-9:106 DCFR, and in Art 2.1.14 UNIDROIT PICC with a special rule for price determination in Art 5.1.7(3) UNIDROIT PICC. All these provisions deal only with the consequences of a failure of the agreed mechanism for determination. They contain nothing on the standard to be observed by the third party or on procedural requirements. They presuppose that it is permitted to delegate the subsequent determination of a contractual provision to a third party. All model rules aim at saving the contract with the help of a court or arbitral tribunal if the third party cannot or will not make the determination. But while the PECL and the DCFR presume that the parties have empowered the court to appoint another third party in such a case, the UNIDROIT PICC provide that, in the case of price determination, the price shall be a reasonable price. In all other cases, the UNIDROIT PICC leave the solution to the agreement of the parties, including any implied terms, and thus remain vague as far as a general rule is concerned. The approach of the PECL and the DCFR can be problematic if a national procedural law does not provide for a procedure to replace the third party and does not allow for an extension of court competences by party agreement. The general ambition to save the contract is also shown by the PECL/DCFR rule that a court may substitute a reasonable term for a determination that is grossly unreasonable. The UNIDROIT PICC relegate this problem to their general rules on fraud, duress or gross disparity.

3. Subsequent determination by one of the parties

Most legal systems in Europe have emancipated themselves from the Roman law prohibition against unilateral determination of the purchase price. Generally, they allow the determination of a contractual term to be delegated to one of the parties, eg by reference to the seller’s list price on the day of performance. The problem at the heart of such a delegation is, of course, striking a balance between observing the parties’ will on the one hand and protecting the other party from being unfairly disadvantaged by such determination on the other hand. Unlike Roman law, countries that allow a unilateral determination tackle this problem directly by providing for judicial review and substitution of an inequitable (Austria: manifestly inequitable) or unreasonable determination. Only where the other party is a consumer (consumer and consumer protection law), a stricter approach is sometimes adopted, eg a total ban on a delegation by means of standard contract terms. To some extent, competition law may also contain restrictions.

The development in France has, however, been quite different. For a long time French lawyers considered the price for many types of contract (but not, for example, for contracts for work, or service contracts) to form a part of the objet of the contract (Art 1129 Code civil). The objet has to be determined or at least determinable at the time of conclusion of the contract by an objective mechanism that is independent of the parties’ will (eg reference to a market price; price determination by a third party is also considered to be such a mechanism). Contracts that provided for the unilateral fixing of a price (eg by reference to list prices in long-term or framework contracts) were void. It was only in the mid-1990s that French courts departed from this position by generally permitting a unilateral determination of the price. If the unilateral power is misused (abus dans la fixation du prix), the other party has a right to terminate the agreement ex nunc and/or to claim damages. From a functional perspective, the claim to damages leads to a substitution of the determination by the court. However, for certain types of contracts, a specific requirement of definiteness of price at the time of conclusion of the contract continues to exist and takes precedence over this more liberal general rule. This holds true, in particular, for the determination of the purchase price (see Art 1591 Code civil that can, in turn, be traced back to the Roman requirement of pretium certum).

The Spanish Código civil generally prohibits a unilateral determination by one of the parties. Only for some types of contract is a unilateral determination within the reasonable discretion of one of the parties allowed; otherwise, the contract does not become valid until the other party has ‘accepted’ the determination. Likewise, the traditional Italian view has been that contractual terms may not be determined unilaterally by one of the parties. More recently, however, the opinion is gaining ground that a power of unilateral determination within a party’s reasonable discretion is permitted.

The European and international model rules (Art 6:105 PECL; Art II.-9:105 DCFR; and, only with regard to price determination, Art 5.1.7(2) UNIDROIT PICC) implicitly assume that the parties may grant to one another the power of unilateral determination. The only express rule that they contain in this regard concerns the abuse of this power. Contrary to the standard found in a number of legal systems, the rules provide that a reasonable term is to be substituted only if the determination is grossly unreasonable. In case of a dispute between the parties, what is a reasonable term will have to be fixed by the courts. All model rules treat this mechanism as mandatory.

4. Uniform law

EU private law contains but a few traces of rules concerning the subsequent determination of contractual terms. Article 6 of the Commercial Agents Directive (Dir 86/653) grants the commercial agent, in the absence of any agreement on remuneration, the right to a remuneration customarily allowed in the place where he carries on his activities and for the goods forming the subject of his agency. Letters (j) to (l) of annex 1 to the Unfair Terms Directive (Dir 93/13) list possibly unfair terms that enable the seller or supplier unilaterally to determine or alter contractual terms (national laws vary because of the character of the annex as just providing examples).

The requirement of definiteness of contract is also laid down in the CISG: in order to constitute an offer, a proposal for concluding a contract has to be sufficiently definite so that, once it has been accepted, a valid contract is formed and obligations arise that can be enforced in court (Art 14). Determinability is sufficient and a contractual term is still regarded as determinable under this rule if the proposal suggests that a term be determined by one of the parties or by a third party. However, a clause granting such a power of determination may be void under the domestic law applicable to the validity of the contract. A famous, albeit largely doctrinal, dispute concerns the question which rules should apply in the absence of a fixed price. According to Art 14(1)2 CISG, an offer has to fix a price or make provision for a (valid) mechanism to determine the price. Only where a contract has been validly concluded without expressly or implicitly fixing, or making provision for determining, the price does Art 55 CISG presume that the parties have impliedly made reference to a market price standard, which the provision specifies in great detail and which may not always be easy to ascertain. The obvious tension between both provisions can be solved by following an (albeit contested) opinion and considering that, on the one hand, prices are generally known and thus impliedly agreed upon in a particular trade and that, on the other hand, Art 14 CISG may be derogated from either expressly or even impliedly by practices or conduct of the parties (furthermore, some countries have excluded this provision from their ratification of the convention). The parties can almost always be held to have derogated from Art 14 where they have empowered either one of them or a third party subsequently to determine the price. The exercise of such a power has to abide by the general CISG requirement of good faith.

Literature

René David, ‘L’arbitrage en droit civil, technique de régulation des contrats’ in Mélanges dédiés à Gabriel Marty (1978) 383; Walther J Habscheid, ‘Das Schiedsgutachten als Mittel der Streitentscheidung und der Streitvorbeugung: Eine rechtsvergleichende Untersuchung’ in Festschrift Winfried Kralik (1986) 189; Denis Tallon, La détermination du prix dans les contrats (étude de droit comparé) (1989); Wolfgang Witz, Der unbestimmte Kaufpreis: Ein rechtsvergleichender Beitrag zur Bedeutung des pretium certum (1989); Reinhard Zimmermann, The Law of Obligations (1996) 253 ff; Tony Weir (tr), Hein Kötz, European Contract Law, vol I (1997) 42 ff; Martin Borowsky, Das Schiedsgutachten im Common Law: Ein rechtsvergleichender Beitrag zum Begriff der Schiedsgerichtsbarkeit (2001); Emmanuel Gardounis, La détermination du prix dans le contrat: Étude comparée entre le droit Français et le droit Hellénique (2007); John Kendall, Expert Determination (4th edn, 2008); Hannes Unberath, ‘Long-Term Contracts and the DCFR—Interpretation and Adjustment’ in Gerhard Wagner (ed), The Common Frame of Reference: A View from Law and Economics (2009) 87; Ulrich G Schroeter, Art 14 nn 2 ff, and Florian Mohs, Art 55 nn 1 ff, both in Ingeborg Schwenzer (ed), Schlechtriem and Schwenzer Commentary on the UN Convention on the International Sale of Goods (CISG) (3rd edn, 2010).

Retrieved from Contractual Terms, Subsequent Determination – Max-EuP 2012 on 25 September 2022.

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