Recurring Obligations

From Max-EuP 2012

by Tobias Tröger

1. Subject matter and purpose

The doctrinal concept of recurring obligations comprises a wide variety of relationships governed by the law of obligations that are characterized by the common duty to perform continuously for a specific period or to be ready to perform at any time during such period. As a consequence of the thus enhanced interconnection of the parties to a recurring obligation, lawmakers in every European private law system face questions of adequate regulation that do not occur, or at most in a less articulate manner, in the case of typical one-shot obligations that are, by and large, settled immediately. Efforts to systematically analyse the doctrinal properties of recurring obligations were undertaken only relatively recently, mainly in German private law scholarship. Comparably overarching institutions cannot be found in Roman law or its reception into continental Europe. German doctrine today uses the well-established expression continuous obligation (Dauerschuldverhältnis) that can be traced back to Paul Oertmann. The first comprehensive scholarly analysis of recurring obligations was delivered by Otto von Gierke in 1914.

Due to this rather late ‘discovery’ of recurring obligations as a discrete legal concept, neither the continental European codifications of the 19th century nor the common law incorporate a separate regulatory framework for such obligations. In spite of this absence of specific rules, every jurisdiction deals with the particularities of recurring obligations either by providing scattered special rules or by appropriately modifying generic rules and standards. The development of a discrete concept of recurring obligations in legal doctrine is corroborated by the concurring evolution of the theory of relational contracts as a new field of research in both law and society and especially in new institutional economics that scrutinizes mainly, albeit not exclusively, the idiosyncrasies of recurring (continuous) obligations. From an economic point of view, the inevitable and—at least partly—rational incompleteness of the parties’ agreement and the non-legal (informal) institutions that stabilize such contracts, particularly with a view to hold-up risks, are of primary interest and have, among other things, been extensively examined by transaction-cost economists (economic analysis of European private law). Certain forms of recurring obligations that enable the coordination of the production and distribution of goods between the antipodes market and hierarchy (firm) (eg just-in-time production, franchising) are discussed in law and the social sciences as ‘contractual networks’ or under similar catch words.

Characteristic examples of recurring obligations are, for example, the lease, financial leasing, loans, service contracts including employment contracts (European labour law), commercial agency (commercial agents), franchising and factoring. In addition, multiple other types of contracts exhibit the characteristic features of recurring obligations. Depending on the specific contractual arrangements, this may even hold for contract types that usually describe prototypical spot transactions, eg sale contracts with recurring delivery obligations, where the intense interdependence and vulnerability of the parties who have devised specific investments is even stronger if the contract additionally stipulates obligations of exclusive delivery.

Among recurring obligations, trusts, partnerships and corporations (company law) occupy an exceptional position. The formation of these contracts creates recurring obligations, especially in the form of fiduciary duties of trustees (see §§ 1, 2 Trustee Act 2000), partners or shareholders. However, depending on the degree to which those assets reserved for the pursuit of the joint activities are legally separated from the private estates of trustees, partners and shareholders, the founding contracts also have an organizational character by setting up an independent legal entity and hence allow for asset partitioning. According to the prevailing opinion, not only trusts and corporations, but also private law partnerships, eg in Germany (Federal Supreme Court, BGH 29 January 2001, BGHZ 146, 341, 343 ff), France (Cour de Cassation, Cass. civ. 23 February 1891, DP 1891, 1, 377), and within limits also in the Netherlands (Hooge Raad 5 November 1976, NJ 1977, 586) and Denmark, possess legal personality. Hence, duties established under the founding contract are not so much rooted in the law of obligations but belong rather to organizational law. Apart from these doctrinal ramifications, organizational contracts share multiple common features with recurring obligations. The latter posit is mirrored in the classical view of institutional economics, where the firm is modelled as a nexus of (incomplete) contracts. Finally, recurring obligations can also occur in the form of non-contractual obligations (eg damages paid as annuities); however, most of the characteristic regulatory challenges only arise if the parties voluntarily enter into the relationship that triggers the recurring obligations.

2. Regulatory framework and tendencies of legal development

The particular characteristics of recurring obligations call for specific answers by all European private law systems which, taken together in their essence, yield a discrete doctrinal structure for the institute of recurring obligations in European private law as well.

a) Limits on commitments beyond a certain time

None of the European jurisdictions allows for an everlasting obligatory commitment (for an express rule see eg § 624 Bürgerliches Gesetzbuch (BGB); even the common law assumes that contracts can be terminated even though they were entered into as everlasting obligations (Staffordshire Area Health Authority v South Staffordshire Waterworks Co 1978 1 WLR 1387). Depending on the facts of the individual case, even a shorter commitment of one party to a contract can be objectionable if the economic self-determination of the party is unduly impaired by such an agreement. In this context, restrictive covenants compelling one to abstain from certain actions, particularly obligations not to compete, are highly sensitive. The Commercial Agents Directive (Dir 86/653), Art 20(3) permits the latter to last for a maximum of two years. Where protection is not granted by special rules, the substantive policy goals can be achieved through the application of the general standards that limit the freedom of contract. Hence, some jurisdictions require, beyond an objectively disproportionate disadvantage as a result of the long-standing obligation, that the aggrieved party was both particularly susceptible and consciously exploited by the other side (see eg the equitable doctrines (equity) of undue influence and unconscionable bargain or the law of the Netherlands, Art 3:44(4) Burgerlijk Wetboek (BW)).

b) Fiduciary duties (of loyalty) and implied terms

The pivotal challenge for the legal treatment of recurring obligations is the inevitable and rational incompleteness of the parties’ agreement. In the first place, the tightly knit relationship of the parties to a recurring obligation can call for special duties of loyalty to each other in order to achieve the contractual goals, even if no explicit agreements have been reached in this respect. Private law systems in continental Europe that are influenced by the Roman law tradition and its bona fides doctrine are able to respond to the not only intermittent and frequently intense interdependence of the parties to a recurring obligation by applying the standard of good faith (particularly clear in Art 6:2 Burgerlijk Wetboek (BW); similar, although with some discrepancies in application, Art 1134(3) Code civil; Art 7 Código civil; Art 1175 Codice civile; § 242 BGB; § 914 ABGB; Art 2 Swiss Civil Code (ZGB); Art 288 Greek Civil Code; § 33 Nordic Contract Statutes). This standard requires the parties to adhere to an adequate degree of loyalty and cooperation (>obligation de loyauté/obligation de coopération). Yet, the common law, which is generally more reluctant to apply a doctrine of utmost good faith in contract law (see Interfoto Picture Library Ltd v Stilletto Visual Programmes Ltd 1989 1 QB 433, 439), also accommodates the peculiarities of certain recurring obligations by providing custom-tailored rules and standards for them. For instance, in the relationship between an agent and principal, fiduciary duties commit the agent to be loyal to her principal’s legitimate interests (see also the obligation of the mortgagee, Downsview Ltd v First City Corp Ltd 1993 AC 295, 312). Continental European jurisdictions, on the other hand, do not automatically attach extensive duties to consider the other party’s interests in any kind of recurring obligation. Therefore, despite the differences in the doctrinal approaches, discrepancies in the outcomes are limited. This is all the more true because in almost every jurisdiction, the particularly sensitive recurring obligations (like lease and employment contracts) are part of specific statutory regulations pursuing similar goals of public policy.

The uncertainty about future developments inherent especially to long-term contractual relationships explains why rational parties, who seek to minimize transaction costs, are reluctant to provide specific stipulations for every conceivable contingency. If such non-anticipated and hence not contractually covered circumstances arise, most continental European jurisdictions allow for an amendment of the incomplete contingent contract based on the principle of good faith and the (presumptive) interest of the contracting parties (Art 1135 French Code civil; Art 1265 Spanish Código civil; Art 1366 Codice civile; Art 6:248 BW; § 157 BGB; § 863 ABGB; Art 200 Greek Civil Code). Conceptually at least, the common law can use implied terms to address incomplete contractual stipulations. However, the doctrine of implied terms is used in a rather restrictive manner. It only applies if the economic goals of the contract could not be achieved without the provision of an implied term or if such term gives effect to the obvious, yet not expressly stipulated, intentions of the parties (eg Mosvolds Rederi A/S v Food Corp of India 1986 2 Lloyd’s Rep 68; Associated Japanese Bank (International) Ltd v Crédit du Nord SA 1989 1 WLR 255, 263). If, however, it is correct that these criteria apply also cumulatively and in a complementary manner, the result is still a relatively flexible system to round out incomplete contractual frameworks that produces results similar to those achieved under the respective regimes in continental European jurisdictions. It is only of secondary importance whether these amendments are indeed the consequence of an interpretation of the contractual stipulations based on the actual, yet unexpressed, will of the parties or whether they rather constitute a normative addition to the contract. Another way the law can react to the incompleteness of contractual stipulations concerning future developments arises from the principles of fundamental change of circumstances.

c) Breach of contract

Specific consequences with regard to remedies for breach of contract result if the violation of a recurring obligation only pertains prima facie to a divisible part of the comprehensive duties under the agreement (eg non/late delivery of a single consignment under a sales contract with recurring delivery obligations). Many European private law systems provide that, where no express agreements on advance performance have been made, obligations are to be performed concurrently and hence grant a right of retention to one party if the other unilaterally fails to perform her duty (explicit provisions to this effect can be found in § 320 BGB; Art 82 Swiss Code of Obligations (OR); Art 374 Greek Civil Code; Art 1460(1) Codice civile; Arts 6:52, 6:262(1) BW. Similar rights are well established by the case law and in legal scholarship in France, Belgium, Austria, Spain and Scandinavia). In the context of recurring obligations, the question arises whether and under which circumstances the non-performance of divisible parts of the comprehensive obligation may amount to a right to retain the entire consideration. To be sure, if the non-performed part of the recurring obligation can be attributed to a separable portion of the consideration, the latter can be retained without question. Whether it is legitimate to exert a right of retention that stretches beyond this frequently depends on a proportionality test: if the partial breach of contract is serious enough to gain relevance for the recurring obligation as a whole, the retention of unconnected parts or of the whole consideration may be justified (for an express rule see Art 6:262(2) BW; a corresponding legal practice also exists in Spain and France; similarly, resorting to the criterion of good faith § 320(2) BGB; Art 1460(2) Codice civile; Art 376 Greek Civil Code).

Similar questions arise if the aggrieved party intends not only to retain the consideration as a reaction to the breach of contract but wishes to terminate the contract and/or to claim damages for its breach. Difficulties emerge particularly if, as a result of a partial non-performance, the disadvantaged party not only seeks remedies with regard to the immediately breached, divisible part of the obligation, but also desires to terminate the entire contract and claim damages for its total breach—which is generally possible as most European private law systems allow the aggrieved party to cumulate the remedies of damages and termination (see also Art 45(2) CISG; Art 8:102 Principles of European Contract Law (PECL)). Once again, the dispositive query becomes whether the partial non-performance exerts a sizeable impact on the recurring obligation as a whole, eg because the creditor’s faith in the debtor’s reliability is profoundly undermined. This principle constitutes either the general rule (§§ 323(4), 281(1)2 BGB; §§ 918(2); 920 ABGB; Art 1564 Codice civile; Art 386 Greek Civil Code; with a slightly more tolerant leaning towards the breaching party also Art 6:265 BW) or is codified as a special rule for particular types of contracts (eg § 31(2) Sale of Goods Act of 1979; §§ 43, 44 Köplagen). Moreover, it has also been generalized and further developed in case law and legal scholarship (France, Spain, United Kingdom).

If the entire recurring obligation is cancelled ex post, it becomes a pressing question whether the termination has an impact also on past performances if parts of the contract have already been correctly settled prior to the breach. Even though the temporal impact of the termination of a contract is not assessed unanimously throughout European jurisdictions, in general (for a retroactive effect see especially the French law; conversely, eg the common law and expressly Art 6:269 BW) their private law systems agree that partial obligations that were duly performed in the past cannot be called into question retroactively and that, therefore, services, goods, payments, etc do not have to be returned. (The résulution (résilation) of a contrat à exécution successive according to French law, for instance, only enfolds retroactivity up to the partial obligation that was breached).

d) Termination

Recurring obligations entail duties over time. The parties to the contract may agree upon the termination of the recurring obligations by setting a time limit, ie the mere lapse of time may end the mutual obligations. If the parties do not agree upon specific ways to end their contract, most jurisdictions allow for a regular cancellation after a reasonable time of notice, either by providing for specific regulations for certain types of recurring obligations or by applying general principles to this effect (eg Art 15(1) Commercial Agents Directive; §§ 620(2), 622 BGB; Art 1705 Código civil; Staffordshire Area Health Authority v South Staffordshire Waterworks Co 1978 1 WLR 1387). In certain areas, eg residential lease and employment contracts, the interest of one party to continue the contract is particularly sensitive. Hence, the possibility to cancel these contracts is frequently limited by statutory law.

In addition, it is common that parties may terminate recurring obligations by an extraordinary notice of cancellation, which sometimes also requires a judicial act. On the one hand, extraordinary cancellations are subject to a higher standard of review with regard to those unanticipated circumstances and conditions that are apt to legitimize them. On the other hand, these reasons are potentially not limited to breach of contract scenarios, which is why extraordinary cancellations go beyond the already mentioned termination as a remedy for non-performance (Art 1467 Codice civile; Art 6:258(1) BW; § 314 BGB). Essentially, extraordinary cancellations represent a manifestation of the clausula rebus sic stantibus. In fact, the cases that give rise to an extraordinary cancellation involve a fundamental change of circumstances in which the arguably less harsh remedy of adjusting the contract terms does not help.

Finally, if the parties have started to execute certain recurring obligations, it is sometimes deemed adequate to either exclude the general reasons that can void a contract in private law and limit the parties to the recurring obligation in performance to cancelling the contract ex nunc or to modify the legal consequences of the contracts invalidity in a way that excludes the restitution of the parties performed duties. Prominent examples occur in Germany with the doctrine of the fehlerhafte Gesellschaft, in France with the sociétés de fait and in Italy and Spain with the regulations contained in Art 2332(2) Codice civile and Art 35(2) Ley de Sociedades Anónimas that implement Arts 12(2) and (3) of the First Company Law Directive (Dir 68/151). In the United Kingdom, issuing the certificate of incorporation is understood as a constitutive act which puts even greater emphasis on the organizational aspects involved in the creation of a corporation and hence leads to similar restrictions on the consequences a nullification of the contract entails. Comparable rules exist in case law and special statutes that govern employment contracts (eg the German and French adjudication on defective employment contracts, Art 9(2) Estatuto de los Trabajeros). Moreover, these rules are increasingly advocated for the law of commercial agents.

3. Regulatory structures in uniform law

The Convention on International Financial Leasing and the Convention on International Factoring are examples of uniform regulations of prototypical recurring obligations. However, both Conventions are isolated and not very successful (yet). Their regulatory structures are inapt for generalizations.

4. Unification projects

A view of certain provisions in the various scholarly unification projects in European private law proves more fruitful. For instance, the mandatory blanket clause of Art 1:201 PECL (Art III.-1:103 DCFR; Art 1.7 UNIDROIT PICC) and the general duty to cooperate stipulated in Art 1:202 PECL (Art III.-1:104 DCFR; Art 5.1.3 UNIDROIT PICC) allow the development of an adequate duty of loyalty that reflects the individual structure of the pertinent recurring obligation. Article 6:102 PECL (Art II.-9:101 (2) DCFR; Art 4.8 UNIDROIT PICC) can serve as the doctrinal basis for the necessary normative amendments to incomplete contingent agreements. Article 9:201(1) PECL (Art III.-3:401 DCFR) and Art 9:302 PECL (Art III.-3:506(2) DCFR) permit the necessary adaptation of remedies for breach of contract. Partial non-performance generally entails consequences only for the part of the consideration attributable to the breached (partial) obligation. Remedies with regard to the entire recurring obligation are only conceivable if the entire contract is affected in a way that justifies such sweeping sanctions. In case of cancellation of the whole contract, already settled partial exchanges remain untouched and do not have to be compensated (Art 9:305 PECL; Art III.-3:509 DCFR; Art 7.3.6(2) UNIDROIT PICC). Furthermore, the academic projects provide that both parties to a recurring obligation may end the contract by notifying the other side a reasonable time in advance (Art 6:109 PECL; Art III.-1:109(2) DCFR; Art 5.1.8 UNIDROIT PICC). An extraordinary cancellation of the contract is also possible if a severe change of circumstances cannot appropriately be accommodated in another way (Art 6:111(3)(a) PECL; Art III.-1:110(2)(b) DCFR; Art 6.2.3(4)(a) UNIDROIT PICC).

Literature

Otto von Gierke, ‘Dauernde Schuldverhältnisse’ (1914) 64 Jherings Jahrbücher für die Dogmatik des bürgerlichen Rechts 355; Steward Macaulay, ‘Non-Contractual Relations in Business: A Preliminary Study’ (1963) 28 American Sociological Review 55; Ian R MacNeil, ‘Contracts: Adjustment of Long-term Economic Relations Under Classical, Neoclassical, and Relational Contract Law’ (1978) 72 Northwestern University Law Review 854; Robert E Scott, ‘Conflict and Cooperation in Long-Term Contracts’ (1987) 75 California Law Review 2005; Gunther Teubner, ‘Piercing the Contractual Veil? The Social Responsibility of Contractual Networks’ in Thomas Wilhelmsson (ed), Perspectives of Critical Contract Law (1992) 211; Hartmut Oetker, Das Dauerschuldverhältnis und seine Beendigung (1994); Donald J Smythe, ‘Bounded Rationality, the Doctrine of Impracticability, and the Governance of Relational Contracts’ (2004) 13 Southern California Interdisciplinary Law Journal 227; Gunther Teubner, Netzwerke als Vertragsverbund (2004); Stefan Grundmann, ‘Die Dogmatik der Vertragsnetze’ (2007) 207 AcP 718; 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.

Retrieved from Recurring Obligations – Max-EuP 2012 on 02 October 2022.

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