Freedom of Contract

From Max-EuP 2012

by Hannes Unberath

1. Subject matter and purpose

Private autonomy is the authorization, within the limits of non-mandatory law, to order a person’s private affairs by means of contract. Freedom of contract, as the central element of private autonomy, follows from the purpose of a contract: state sanctioned contractual obligations permit cooperation through the exchange of performances between autonomous actors. Private parties determine which acts they oblige themselves to perform and to whom these performances are due. In contrast, if the state were to determine who are the parties to a contract, and to use mandatory law (ius cogens) to determine the content of the contractual relationship, then not only would freedom of contract be set aside—which in some legal systems (eg Germany) would contradict its constitutional guarantee—but one could no longer speak of a ‘contract’. Although one often reads that the history of freedom of contract is the history of its limitation, one should also remember a well-known comment by Sir Henry Maine, namely that the progression from primitive social structures to those of the classical Roman law period was the progression from status to contract.

Structural norms, derived from the essence of contract, must be distinguished from interferences with freedom of contract, derived from the respective legal system, that impose extra-contractual standards on to a contract. Standards of accountability establish the conditions under which courts will evaluate the parties’ declarations—particularly when concluding a contract—as ‘voluntary’ and thus self-determined. Since such rules of imputation set the conditions allowing the possibility of contract they cannot be determined by the contract itself. Examples are the requirement of capacity to contract and the rules on mistake. Which degree of personal responsibility a person must have to engage in legal transactions and how this responsibility should be precisely defined raise questions that are at the foundation of the private legal order and are the subject of fundamental disputes. Although representatives of the rivalling schools criticize each other for misconceiving the premises of private autonomy, these theories share the central goal of fostering and not eradicating freedom of contract. Likewise, the rules effectuating the binding nature of a contract, such as the obligation to pay damages in money for breach, are not limitations on the freedom to contract. Enforcement of the rights arising from a contract is not a hindrance to, but inherent in the freedom of contract: the essence of a legal transaction is an individual will that the legal order recognizes by ‘effectuating’ the desired legal structure in the legal world. Furthermore, non-mandatory law does not in principle impose external limitations on freedom of contract. Default rules (dispositives Recht) are necessary because contracting parties frequently express their intentions insufficiently, and since such law is aimed at fulfilling and not defeating the parties’ intention, it must be non-mandatory. A paradigmatic example of such a rule is provided by § 269(1) Bürgerliches Gesetzbuch (BGB), which locates the place for performance at the debtor’s residence unless the parties have agreed otherwise.

In contrast, freedom of contract is limited on the basis of external considerations when contracts are not recognized because they pursue goals rejected by the legal system, such as the commission of a crime. The invalidity of such contracts follows from the requirement of consistency within the legal order. Limitations on freedom of contract that neither advance the fulfilment of the parties’ intentions nor aim to prevent rejected contractual purposes are the most intensive form of external interference and thus always require special justification. Paradigmatic of such norms are those that use mandatory law to determine the content of the contract (eg the amount of payment), to regulate the end of long-term contracts (recurring obligations), or to formulate the conditions for the selection of one’s contractual partner (eg rules protecting against discrimination (discrimination (contract law)).

2. Tendencies in legal development

a) Economic system

A restrictive attitude intending the protection of private individuals (paternalism) has prevailed over the course of the 20th century in most western European states and in the European Union, an approach which can be seen both in the prerequisites for exercising freedom of contract and in the external limitations placed on freedom of contract. This trend is striking because in the second half of the same century the European economic system (European economic constitution) has in fact improved the prevailing market conditions through the regulation of competition and the implementation of the fundamental freedoms. On the other hand, the number and intensity of substantive emergency situations preventing a free decision have in fact been radically reduced with the rise of the social welfare state. Notwithstanding the restrictive trend noted above, freedom of contract has recently witnessed a renaissance in eastern Europe following the collapse of the socialist systems.

Competition law is based on substantive criteria since it attempts to improve the conditions for freedom of contract by ensuring genuine alternatives and by intervening in market activity with a multitude of measures, particularly in order to prevent monopolies. Nonetheless, a meaningful ordering of market conditions must be premised on the autonomy of the law of contract and an appreciation of its relation to private initiative. Limiting intervention to the enforcement of the parties’ genuine intention is also a fundamental requirement of the economic theory which considers contract—in an ideal world having neither transaction costs nor external effects—as the prime guarantor of an efficient allocation of resources.

b) Procedural and substantive approaches

According to today’s shared understanding in Europe, the institution of contract—as well as private property—is necessarily dependent on regulation through the legal order, yet the rules of the legal order, in turn, have to be evaluated against the ideal of freedom of contract, ie the right to exercise basic self-determination in the formation of legal relations.

Traditionally, the standards for evaluating the conclusion of a contract (contract (formation)) are marked by a procedural and substantive differentiation. A contract is seen as ‘procedurally just’ if the contracting party is fundamentally capable of entering into legal transactions and no factors were present to disturb the process of contract formation. Classically, reasons for rejecting voluntariness have been duress and mistake. Substantive approaches, in contrast, are based on the content of the contract. An example is the laesio enormis of the ius commune, eg in § 934 Allgemeines Bürgerliches Gesetzbuch (ABGB), according to which a contract can be invalidated if what has been promised for a performance falls fifty percent below its ‘true’ value. According to this approach, the state rather than the parties determines a iustum pretium which, in the final analysis, imposes an external limitation on freedom of contract. Walter Schmidt-Rimpler’s often-cited thesis of contractual Richtigkeitsgewähr (‘correctness guarantee’) is part of a substantive theory which, through first looking to procedural elements, ultimately subjects the terms of the contract to (unlimited) external control.

The original position of German and French law emphasized procedural standards, which were sometimes combined with substantive criteria. Formal procedural elements still dominate English law. The Bürgerliches Gesetzbuch (BGB) recognized no conditions that would limit the effectiveness of a manifestation of intention other than those regarding capacity to contract and lack of consent due to duress, deception (fraud) and mistake (cf in French law erreur, Art 1110, violence, Art 1112, dol, Art 1116 Code civil). An obvious disproportionality in performances was insufficient under § 138(2) BGB to render the contract invalid: in addition, a situation of emergency or the inexperience of the other party had to be ‘exploited’. Similarly, French law originally rejected lésion as a ground for invalidity (see Art 1118 Code civil, with exceptions, eg Art 1674 on real property). The requirement of a defect in consent was not subsequently abandoned, but case law moved the focus to substantive criteria when it began to presume procedural defects for transactions ‘similar to usury’ in those instances where substantively specified disadvantages arose (RG 13 March 1936, RGZ 150, 1).

Rules on standard contract terms were reviewed relatively early (first under § 138 BGB and—without explicit statutory empowerment—on the basis of good faith; see now the directive on unfair terms in consumer contracts (Dir 93/13), §§ 305 ff BGB). Although judicial decisions are guided by the ‘degree of justice’ inherent in the default rule that the standard term in question seeks to abrogate (BGH 17 February 1964, BGHZ 41, 151), judicial intervention into a contract is premised on a defect that is procedural in its core, namely it is not always practicable to take note of the content of prefabricated and lengthy standard terms at the stage of precontractual negotiation, given the scarce resources typically available. In addition to these chiefly procedural limits, economically motivated external or substantive limitations have always existed, for example the passenger’s right to enter into a contract for certain public transport contracts.

c) Equality of contract and the social welfare state

From the end of the 19th century onwards, freedom of contract witnessed a significant structural transformation. As early as 1958, Ludwig Raiser had commented that the BGB’s underlying concept of a free and self-determined person (‘freie selbstverantwortete Persönlichkeit’) could not be accepted without ‘alteration’. In the 1970s, Ernst A Kramer similarly attested to the ‘crisis’ of liberal contractual thought. Such positions contrary to the BGB’s original principle of ‘formal by equal freedom’ (Joachim Rückert) had been already formulated by contemporary critics of the BGB. This countervailing position ostensibly adhered to the procedural concept of contract, but it characterized the voluntariness of concluding a contract no longer simply as being negatively ‘formal’ through the absence of deficiencies of consent (duress or mistake), instead requiring positively that the contracting parties had had ‘real’ freedom of decision. Conceptually this requirement was subsequently expressed in the demand for ‘contractual parity’ (Vertragsparität) (particularly Günther Hönn, who adopted the approach articulated by the German Federal Labour Court, BAG 31 October 1969, NJW 1970, 1145; in England, Patrick Atiyah favoured a similar analysis; conversely, Lord Denning’s approach of inequality of bargaining power in Lloyd’s Bank Ltd v Bundy [1975] 1 Q.B. 326 has remained isolated). If the contractual parity is ‘disturbed,’ autonomy is in danger of being replaced by heteronomy and contract law must intervene as a compensatory mechanism to protect the weaker party. The apex of this development seems to have been reached in the so-called ‘suretyship decision’ of 19 October 1993, BVerfGE 89, 214, in which the German Federal Constitutional Court (Bundesverfassungsgericht) expressly required the private law courts to review every contract that is substantively disadvantageous for one party in order to determine ‘whether the agreed contractual terms resulted from a structurally unequal bargaining position.’ The result of the well-intended protection of the ‘weaker’ party, as with every paternalistic approach, is the transfer of responsibility to the state and the limitation of the individual’s ability actively to manage his own legal affairs.

That the factual scenario underlying the ‘suretyship decision’, in which the debtor’s close relatives assumed potentially ruinous suretyship arrangements, could have been solved by using classical procedural approaches is demonstrated in the parallel decisions of the English courts (Royal Bank of Scotland v Etridge (No 2) [2001] UKHL 44). Consumer protection in the formation of contracts (consumers and consumer protection law), seemingly wearing the protection of the ‘little man’ against the ‘large concern’ on its sleeve (as stated by Lord Denning in George Mitchell (Chesterhall) Ltd v Finney Lock Seeds Ltd [1983] QB 284), can likewise be rationalized mainly as a reaction to procedural defects at the stage of contract formation, even though these mechanisms operate with considerable generalizations. Paradigmatically, concluding a contract in a doorstep situation is an example of when it is assumed that the consumer caught off-guard has been subject to a defect in his freedom of decision. Furthermore, the various duties of information (eg regarding effective annual interest rates for credit) are aimed at ensuring that a contract is procedurally flawless and, therefore, are also basically compatible with classical contract doctrine.

The transition of rules of contract law from defining freedom of contract in procedural terms and focusing on deficiencies of consent to promoting purposes external to the contract under the auspices of parity and the ‘ethos of the social welfare state’ (Franz Wieacker) is fluid. The tendency to model the content of particular types of contracts featuring presumptively ‘weaker’ contracting parties by mandatory law consciously separates itself from classical liberal models of contract. The development in Germany is typical of other European nations, particularly France (dirigisme, Code de la consommation of 1992). The rules on individual labour law as well as ‘social’ landlord-tenant law and types of contracts associated with consumer protection law (sale of consumer goods; consumer credit (loan); package travel contracts (package tours), etc) are of practical relevance in this respect. Although the limitations in landlord-tenant law were first required by a market disparity and housing emergency, the regulation of labour law was intensified during a period of relatively large demand for workers following the end of World War II. Mandatory rules can be found for individual contractual aspects such as workers’ vacations or the refurbishment of living space. Apart from that, restrictive mandatory regulations are in place mainly with regard to the termination of the long-term contractual relationship at issue (eg the social criteria which must be taken into account with regard to the dismissal of an employee made on company-related grounds under § 1(3) Kündigungsschutzgesetz (KSchG) or the requirement of a justification for giving notice to a tenant under § 573 BGB). Moreover, certain types of service contracts are regulated comprehensively eg, in Germany, the payment for medical treatment or legal services. Finally, so-called ‘public service’ contracts (Daseinsvorsorge), where the state provides certain services and assumes a monopoly position, are regulated almost in their entirety. In these sectors, the service provider is generally obliged to contract with whoever requests the service. However, in certain sectors, such as energy and telecommunications, privatization—and with it competition—has begun.

Just which distributional and other economic effects flow from comprehensive interventions imposing external limitations on freedom of contract is as much debated as the basic question of whether the institution of contract is at all suitable from a principled and economic point of view to achieve distributive justice. The opposing, traditional position does not necessarily require the dismantling of protections in place for ‘weaker’ parties, such as workers or tenants, but instead attributes this responsibility to the social welfare state. Such a strict separation of private law, having a procedural and content-neutral character, from public law, which has the responsibility to create the conditions for unimpeded self-development, corresponds most closely to the original conception of the BGB.

In addition to the protective mechanisms that are connected to the market implications of contract, a new tendency is oriented toward scrutinizing the choice of one’s contractual partner, as well as the content of a contract, for their appropriateness according to ‘values’ determined by the state, eg particularly in relation to the equal treatment of genders and the protection against discrimination on the basis of race or other characteristics (discrimination (general)). Accordingly, contracts have no value in themselves but have value only insofar as the contractual purpose is worthy of recognition (described particularly in the perfectionist liberalism of Joseph Raz). Criticism of this approach is not based on the goals followed by this materialization of contract law, but simply questions the state’s competence to regulate this area.

3. European uniform law

The extent of freedom of contract is interpreted in the Principles of European Contract Law (PECL) differently from the Draft Common Frame of Reference (DCFR). The main reason for this divergence is the DCFR’s effort, in accord with corresponding work of the so-called ‘Acquis group’, to take account of the regulatory approach of European secondary law, which reveals a tendency to protect consumers. Because mandatory law appears to be an anomaly in the light of private autonomy, the attempt to derive contractual principles inductively from the current acquis communautaire has met with criticism.

The PECL (similarly, in this respect, the UNIDROIT Principles of International Commercial Contracts (PICC)) do not consider external limitations on the freedom of contract (wrongfulness, unconscionability), an area on which national traditions strongly diverge. In general, the rules contained in these instruments are limited to the core elements of contract law and do not in any way indicate which of the rules have a mandatory character, leaving this question to be answered by the nature of the rules themselves. Ch 4 has detailed rules on mistake, fraud and duress, as well as on the policing of standard terms. These basic rules contain no further-reaching requirements concerning ‘real’ contractual parity; in particular, the problem of the ‘suretyship decision’ is solved by means of procedural devices (with reference to the abusive nature of a situation of distress or the surety’s inexperience). Chs 8 and 9 lay down the remedies for enforcing a contract.

The DCFR very largely takes over the structural rules of contract law contained in the PECL without alteration, but supplements them in essential respects. For example, the DCFR adopts the approach concerning the policing of the content of standard terms, but abandons the focus on consumer protection; also it takes account of the Unfair Terms Directive and proposes a list of generally impermissible terms (Art II.-9:411). Additionally, the DCFR adopts from secondary EU law such as the Doorstep Selling Directive (Directive 85/577) the procedurally explainable mechanisms of consumer protection affecting the formation of a contract (in particular information obligations, eg Art II.-3:102 and rights of withdrawal, eg Art II.-5:201). With regard to external limitations, the DCFR establishes, for the first time, the rule that any aims disapproved by EU law cannot be the object of a contract (Art II.-7:401). Furthermore, the DCFR incorporates the requirements of the Anti-discrimination Directive (Art II.-2:101 ff). In the areas in which the DCFR, for the first time, covers specific types of contract at the European level, it takes the same restrictive attitude toward freedom of contract as does secondary EU law generally. Article IV.A.-4:102, for example, replicates the mandatory character of the regulation on remedies for deficient performance, as contained in the Sale of Consumer Goods Directive (Dir 1999/44), and even extends it to include damages. Moreover, even in areas in which secondary EU law does not recognize mandatory regulation, the DCFR repeatedly prefers it (eg Art IV.C.-8:103). The DCFR thus reflects the restrictive tendencies of secondary law which have been strengthened through the case law of the European Court of Justice (ECJ).

European law, however, has generally had a deregulatory effect since its inception because the ECJ decided at an early stage to measure national limitations on trade in goods and services, the movement of capital and the freedom of movement directly against the fundamental freedoms of the EC Treaty (EU Treaty). External limitations on the freedom of contract thus need to comply with the principle of proportionality to the extent that they significantly influence cross-border transactions. One can, therefore, observe two opposing currents within European law as concerns national limitations on the freedom of contract: on the one hand, the restriction and paternalistic consumer protection by EU legislation and, on the other, the guiding principle of free trade.

Literature

Walter Eucken, Grundsätze der Wirtschaftspolitik (2nd edn, 1959) 276 ff; Franz Wieacker, ‘Das Bürgerliche Recht im Wandel der Gesellschaftsordnungen’ in Festschrift zum hundertjährigen Bestehen des deutschen Juristentages (1960) 1; Arthur T von Mehren, ‘A General View of Contract’ in IECL VII/1 (1982) ch 1, paras 72 ff; PS Atiyah, The Rise and Fall of Freedom of Contract (1985); Wolfram Höfling, Vertragsfreiheit (1991); Werner Flume, Das Rechtsgeschäft (4th edn, 1992) 6; Michael J Treblicock, The Limits of Freedom of Contract (1993); Joachim Rückert, ‘Vor § 1. Das BGB und seine Prinzipien: Aufgabe, Lösung, Erfolg’ in Mathias Schmoeckel, Joachim Rückert and Reinhard Zimmermann (eds), Historisch-kritischer Kommentar zum BGB, vol I (2003) nn 43 ff, 72 ff; François Terré, Philippe Simler and Yves Lequette, Les obligations (9th edn, 2005) 37 ff, 379 ff; Nils Jansen and Reinhard Zimmermann, ‘Restating the Acquis communautaire? A Critical Examination of the “Principles of the Existing EC Contact Law”’ (2008) 71 MLR 505.

Retrieved from Freedom of Contract – Max-EuP 2012 on 06 October 2022.

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