Why is Comparative Commercial Law Needed?
Introduction
During the past few months I have received requests from colleagues willing to use my Hornbook Comparative Commercial Contracts: Law, Culture and Economic Development in their classes in Argentina, China, Chile, Costa Rica, Japan, Mexico, Spain and the U.S. Most have asked me for a “healthy” syllabus that their students could read in preparation for their reading of major portions of the Hornbook. Some have asked me to tell these potential readers what is unique about my book, especially here and now. I am happy to oblige and can only hope that I have selected the proper illustrative segments.
Comparative Commercial Contracts: Law, Culture and Economic Development was written as a companion to my courses on Comparative Commercial Law I and II. It reflects the global nature of today’s commerce and the importance of commercial law as a key tool for economic development. Unfortunately, most civil law lawyers, legislators and judges are largely unaware of how commercial contract law works in common law countries and vice versa. Thus, civil law lawyers do not know, for example, why a firm offer under UCC Section 2-205 is a binding contract while not so (until recently) under the French and French inspired codes. Similarly, U.S. commercial lawyers are often baffled by the strict-literal manner in which many civil law countries interpret their commercial contracts. They cannot understand why the remedies for breach of contract are so frequently limited to the recovery of principal and interest while United States law allows the recovery of direct, indirect and consequential damages, including the loss in the volume of sales.
I hope that both realize that the knowledge gap cannot be bridged by a textual comparison; it requires an understanding not only of the “laws in the books” but also of the business and legal cultures (attitudes and values) and practices of the parties, legislators, lawyers and adjudicators (“the living law”). Only such a contextual understanding can enable the national and international commercial law to truly contribute to society’s welfare.
This course and Hornbook are the result of my life experience as a lawyer who studied, practiced and taught law under different legal systems and business and legal cultures. In addition, I was involved in the drafting and implementation of significant international treaties and of national statutes in the U.S. and in Latin America. The latter task required access to empirical information not only on the socio-economic peculiarities of the country or region, but also of the marketplace behavior of commercial archetypes, i.e., representative merchants for the sector in question and especially of the behavior of the most respected merchants for their knowledge, honesty, reasonableness and fairness. Accordingly, archetypal practice was the principal source in my compilation of “standard” practices, i.e., those practiced by the regular participants when dealing with each other, as well as for “best” practices, i.e., those that protected regular participants as well as third parties, especially those parties who lacked the knowledge or bargaining power to fend for themselves.
Part I (Chapters 1-19)
A. Methodology
Part I discusses the methodology employed by the Roman jurists when issuing their opinions on the parties’ rights and duties and of their actions and defenses thereby shaping what the great Romanist and legal philosopher Rudolf von Jhering referred to as the “legal alphabet” of the western civilization. It contrasts this methodology by that employed by the draftsmen of France’s civil and commercial codes and by English judges who helped to shape the common law and eventually commercial law. It shows the severe limitations of the empirical universe relied on by French codifiers when legislating for most of the western civilization. One of their principal sources was the Roman Corpus Juris (6th century AD), especially its digest of opinions of Roman Jurists of earlier centuries (a database considered by many European 18th and 19th century scholars as the highest manifestation of private law science). What if after carefully studying that source they concluded that a very limited number of rights in rem existed in Roman law and thus were possible: Mortgages for real property and pledges for personal property? What if the codifiers deduced from this dichotomy the permanent and universal features of these rights in rem and this deduction made them conclude that these rights can only be exercised over tangible or corporeal things such as land or goods? Does it follow that presently the creation of rights in rem in intangible things, such as accounts receivable, must be proscribed even though these accounts are among the most desirable forms of collateral in present day developed and developing nations? Note that the present day conclusion is not based upon empirical evidence of what is being used successfully as collateral in the marketplace but on a factually deficient syllogistic deduction. Obviously, such a proscription would be unwarranted, yet it continues to be made by present day legislators, commercial lawyers and law professors in developing nations out of respect for Aristotelian syllogistic logic of permanent and universal essences supported by flawed empirical findings.
In contrast, the Logic of the Reasonable, which is the logic that permeates U.S. commercial law making and adjudication, tries to resolve commercial contract law issues such as: 1) how to best secure the rights of commercial creditors by allowing their acquisition of rights in rem on the most liquid types of collateral (by liquid I mean quickly and cheaply convertible into money); 2) by taking into account contemporary practices as well as the experience with existing and past practices, rules, concepts and principles; and 3) by attempting to anticipate the likely social consequences of adopting alternative principles, rules and concepts. Notice that the object of this logic is not to come up with permanent and universal essences and definitions or classification of rights in rem. It regards definitions and classifications as means to attain desirable normative goals or policies. It is a fact based logic whose purpose is to help solve the practical problems of justice, among other socio-economic problems.
In commercial law making (including adjudication), the Logic of the Reasonable relies consistently on the behavior of representative or archetypal merchants, such as that of: the Roman Bonus Vir (“a respected man of affairs”; the German Commercial Code’s Ordentlicher Kaufmann (“a proper and decent merchant”) or U. S. Federal Judge Henry Friendly’s reasonable merchant in his famous Frigaliment Importing Co. v. B.N.S. International Sales Corp “what is a chicken” decision. This was a decision in which he concluded, inter alia, that it was unreasonable to expect a merchant/seller to sell his chickens at a price that necessarily entailed a loss for each pound of chicken sold.
B.Some Guiding Principles of the Pre-Commercial Society
Prior to the emergence of syllogistic logic, and surely prior to the Logic of the Reasonable man, was a social animal and an animal struggling to survive and prosper, at first as a hunter gatherer and subsequently as part of agricultural and fishing communities. During this period, a set of guiding principles of his pre-commercial society became apparent:
1. Communal Living entailed a “dense” set of fixed, relationships of reciprocity, reliant on duties to exchange hunted or gathered goods as well as services designed to insure the survival of the members the clan, tribe or family. Thus, once a community’s hunter or fisherman, always a community’s hunter or fisherman. This principle led to the absence of upward social mobility and to the prevalence of an established status. There were no contracts with which to change the fixed relationships.
2. Most transactions were communal, only occasionally did community members deal with non-community members and when they did, they treated the non-communal strangers in a manner unequal to that in which they treated the members of their communities.
3. In the pre-commercial community, valuable family property was kept in the family fold as an ultimate insurance of survival.
4. The family’s liability was continuous, from generation to generation and was unlimited.
5. To the extent that agents were designated, they could not harm their principals; thus, an agency that turned out to be harmful to the principal was not binding on him.
6. To the extent that promises to do or give something were made, they required immediate execution, and promises to do or give something in the future were unenforceable.
C. Some Guiding Principles of a Commercial Society
1. Individual family or family members could choose what to sell and exchange and what services to perform.
2. Individual family or family members had regular dealings with strangers and learned to treat the strangers equally to the manner in which they treated their family or they risked the loss of their business.
3. Valuable family or individual property could be, and usually was, sold, exchanged or used as collateral.
4. Limited personal liability could be chosen as long as certain legal requirements were fulfilled.
5. An agent with apparent authority from his principal binds the principal, regardless of his actual authority.
6. Promises, whether immediately executed or executed in the future, are binding subject to legal requirements and regardless of the immediate acceptance by the promisee.
D. Commerce in the Middle Ages (Chapter 5)
1. At one point, long distance trade was only possible by caravan in which the merchant invariably accompanied his wares. The replacement of the caravan in Mediterranean trade was possible when the wares were entrusted to travelling “brotherly Jewish merchants.” It was a trust based on oaths and brotherly-religious duties enforced by religious courts.
2. Guilds and monasteries were among the first institutional producers of goods and services. They had rules of membership and hierarchy; their prices were fixed and aspired to be just. Max Weber referred to one such an aspiration as the Nahrugsprinzip (prices that enable the guild member to retain his status in the guild or in the monastery). The competing aspiration was attributed to St. Thomas Aquinas’ prices in accordance with the estimation of the market (Secundum Aestimationem Fori).
3. Some fairs and fair courts enacted ordinances to ensure an equal treatment for all the participating merchants, regardless of their origin. They were known to be responsible for the “Peace of Market Place”, a decisive step in the European unification of the law of merchants.
E.The 19th Century, Representative Commercial and Civil Codes and Archetypal Merchants (Chapters 9- 12)
How were the most representative European commercial and civil codes drafted and how are they applied in every day commercial life and why? The answer to the “why” lies with the cultural influences and commercial and “civil” archetypes of contractual behavior: the French civil law land owning bourgeois juxtaposed with Napoleon’s “tricky” merchant and with the German “honest decent merchant.” How did legislators’ and judges’ reliance on these archetypes influence the development of their respective economies? Why was it that by the end of the 18th century, England was developing a marketplace for public and private negotiable instruments? Or in Lord Mansfield’s wordsin Miller v. Race: “[instruments that are] treated as money, as cash, in the ordinary course and transaction of business, by the general consent of mankind…they are so much money as guineas themselves are…” Meanwhile, in France, Spain, and much of Latin America and Africa such quasi money did not emerge until at least a later. Did the French Civil Code’s contractual “causa” have something to do with it? Or, was it Napoleon’s distrust for merchants and instruments such as bills of exchange, which he regarded as “tricky” merchants’ devices to evade the prohibition of usury.
What about the archetypes of commercial contract law of socialist nations such as those of Leninist and Stalinist Russia and of the post Mao market socialism of the PRC (Chapters 14-19)? What was the effect of central planning on Soviet economic development or lack of it? Was Ludwig von Mises right when he warned Soviet economists that central planning would fail because of its disregard of representative market prices? You will also read about my own experience while trying to buy a suit in Marxist Bulgaria and about Cuba’s experience with Che Guevara’s disregard of cost accounting and market prices as interim president of Cuba’s Central Bank. Was he an archetypal banking regulator or a violent revolutionary bent on accelerating what he was certain would be the transition from socialism to a communism (a state of being in which there would be no private property, markets, merchants, banks, costs and prices)?
F. Commercial Living Law and Archetypal Practices in Familistic Cultures
Regardless of the enactment of the most influential 19th century European codes, the normative significance of the living law of developing countries, such as in Latin America and China is paramount (Chapters 14-19). The Chinese Guanxi, a familial or friendly method of doing business, has its counterpart in the Mexican Compadrazgo inspired business practices. These relationships are exclusive to family and close friends who are expected to help each other when needed so that in the long run, the participants do well. Can you see why many of these practices lead to monopolistic schemes, especially when one of the parties is a government official? And can you see whether almost invariably the familistic treatment is often at the expense of some stranger (third party). Note that when Confucius tells a disciple that “a father must always shelter his son, as the son must always shelter his father” (no matter the harm that that father or son may have inflicted on a third party), he does not seem concerned with the fate of the victims of the theft of sheep, the protection of strangers acting as bona fide purchasers or secured creditors.
Accordingly, could a secondary market for real estate mortgages exist when the land sold or mortgaged has a familistic clause that states (more or less): “this land is sold as a result of the economic necessity of the seller’s family?” This was an ancient, pre-commercially inspired Chinese clause which appeared in many conveyances of family land until the early 20th century. It warned the buyers of ancestral family land that a descendant of the necessitous family could repurchase the land sold by paying what the original buyer paid. Presently the beneficiary of the forced reversionary sale is the PRC as owner of most of China’s real property (Chapters 18 and 19).
Part II: The Legal and Socio-Economic Context of Anglo American Commercial Contract Law (Chapters 20- 21)
A. Gifts, Giving and Entrustment in English Contract Law and Practice
The first two chapters of Part II (Chapters 20 and 21) are devoted to the socio-economic and cultural context of Anglo-American commercial contract law. Why did London become the world’s leading financial center during the 18th century? It is true that much of the money lent to struggling English merchants came from the large profits yielded by the cruel exploitation of sugar producing slaves in England’s Caribbean colonies. Yet the trusting manner in which this money was lent was reminiscent of gift giving in English feudal society where gifts were given by those seeking to attain social mobility to those who could make their upward mobility possible. Mutatis mutandis, English 17th and 18th centuries’ moneylenders and bankers lent their money at market rates of interest and thereby insured the borrower’s gratitude, trust and continuous business. Note that in these loan agreements, the initial step was the lender’s advance of his money, “in consideration” of which (read a customary clause) the borrower promised to repay principal and interest. This advance took the place of the gift as a token of entrustment in the formation of commercial contracts and as the template for other contracts. Not surprisingly, by the end of the 17th century consideration had displaced the canonic and civil law requirement of causa as a key element for the enforcement of commercial contracts.
I was a late 20th century beneficiary of this giving and entrustment method of contract formation. As a young and barely solvent law professor, I visited London’s Wildy and Sons bookstore. Upon finding out that I was a friend of one of their customers, Wildy’s sold me two valuable historical commercial law treatises on credit; during the following forty years of teaching and research, I reciprocated Wildy’s entrustment with many more purchases.
B. Lord Mansfield’s Role as a Framer of a Market Sensitive, Reasonable and Fair Commercial Law (Chapter 20)
Of special interest in the English court system was the reliance of some of its civil courts on merchant jurors. No one made better use of these jurors as describers of commercial practices than Lord Mansfield, the western world’s most influential judicial shaper of a market sensitive, reasonable and fair judicial law of commercial contracts and negotiable instruments. His decisions enshrined a version of good faith that required above all honesty, but not too far behind the parties’ reasonableness and fair dealing. For Mansfield it was only reasonable to expect a purchaser of a maritime insurance policy to place himself in the position of the insurer, who had to rely on the purchaser’s disclosure of maritime risks unknown to him. The purchaser’s failure to disclose those risks was therefore seen as dishonest, unreasonable and unfair and warranted the application of appropriate legal and equitable remedies. Lord Mansfield also contributed to the incipient English (and later mature U.S.) law of the implied warranty of merchantability and fitness for the agreed purpose. The underlying principle of this law was that payment of a fair price presupposes a fair warranty.
C. The Socio Economic Context of United Sates Commerce: Puritanism and Credit or The Business of America is Business and the Customer is Always Right
The initial impulse for a viable agricultural/commercial society in the 13 colonies owed much to of the following puritan virtues: hard work; concern for family and community; entrustment of money, goods and services to close and extended family; observance of just prices and abhorrence of usury; and a marked preference for private over communal property. Most of the goods and products that could conceivably be produced in America or imported from England were for sale in 18th century “general” stores, including the one in Fredericksburg, Virginia where George Washington’s family habitually shopped. Its wide variety of goods was often sold on credit terms that matured with the harvest and sale of Virginia’s agricultural products.
Even though by the turn of the 19th century the influence of Puritanism had sharply decreased, the omnipresent concern with business success continued in the modus operandi of American’s late 19th century department stores and their consumer credit accounts. Two key policies of the merchandizing uber alles attitude were expressed by a Mr. Harry Selfridge, one of Chicago’s Marshall Field’s owners and later an equally famous London retailer:“always give the lady (customer) what she wants” and if this policy was not clear enough, then: “the customer is always right.” These policies soon became associated with the behavior of America’s archetypal, and mostly large, retailers.
Hand in hand with massive retailing was the credit provided to retailers by wholesalers and factors. They relied on the collateral of inventory and accounts receivable for a new type of loan eventually known as a secured “line of credit.” In this loan, the amount lent depended not on the value of the merchant’s real property or on his bank deposits, but on the ratio between this amount and the value of the borrower’s collateral (including his inventory, accounts receivable and proceeds thereof). Thus, the amount lent increased with sales revenues larger than anticipated or decreased with poorer ones. Credit bureaus that gathered data on the creditworthiness of businesses and businessmen also contributed vital information to actual or potential lenders. Eventually, these bureaus could be found throughout the U.S. and their reports on the data on the creditworthiness of potential borrowers in general could be combined with the specific information on the value of the debtor’s available (unpledged) collateral. This data became an integral part of the U.S. formula of commercial creditworthiness: the debtor’s willingness and ability to repay, as apparent in his credit bureau track record plus a secured (collateral) source of repayment.
The Federal Reserve Act of 1913’s mission was to provide “a safer, more flexible and more stable monetary and financial system.” Flexibility referred to the need to eliminate a pre-existing system of rigid, fixed reserves that impeded bank lending beyond the fixed amounts. This also impeded the wider reliance on liquid private quasi money, such as the bankers’ acceptances of their customers’ drafts or bills of exchange payable at future (maturity) dates. Often the repayment of this quasi money was secured by pledged “readily marketable staples.” The member banks’ acceptances added certainty and liquidity of repayment to this quasi money because the banks were the parties primarily liable to pay those bills at maturities not to exceed 90 days. The Federal Reserve Act enabled the discount of these acceptances by member banks at the Federal Reserve discount window thereby replenishing their lending capital and injecting new liquidity into the banking system. Presently, the Federal Reserve Bank relies on more direct, immediate and inclusive methods to provide what it assesses as needed liquidity. It does this not only for the U.S. marketplace but for others as well, often in conjunction with the International Monetary Fund and other regional or multi-national financial institutions.
D. The Maximalist Version of American Freedom of Contract
The U.S. law of commercial contracts has been strongly encouraged throughout its existence by a maximalist version of freedom of contract: that which the law does not expressly forbid, it allows. The pros and cons of this principle and its deference only to express prohibitions are illustrated by a 19th century multi-party contract initiated by an entrepreneurial New York railroad car conductor. While routinely traveling between upstate New York and New York City, he noticed the large amount of unutilized storage space in railroad cars. He convinced the railroad for whom he worked to fill up the empty spaces with containers of fresh milk produced in upstate New York for sale in New York City. Soon, this daily supply of fresh milk generated large profits and prompted a flurry of novel contracts between or among producers, transporters and distributors of the milk. Yet, consistent with the maximalist version of freedom of contract, many of these contracting parties joined with others in order to maximize their profits at the expense of weaker participants in the same transactions. Not surprisingly, such monopolistic attempts by producers, distributors and transporters wound up in court.
E. The Constitutional, Statutory, Judicial and Administrative Suppression and Correction of Monopolistic, Unfair and Abusive Commercial Practices
The U.S. marketplace owes much of its vitality to the constitutional, statutory, judicial and administrative suppression and correction of monopolistic, abusive, unfair and harmful practices. The U.S. Constitution supported free and fair trade by giving the federal government the right to govern interstate commerce and, with it, an equal protection of those whom the law regarded as equals. The Sherman Antitrust Act of 1890 was one such a protective law. It prohibited anti-competitive business practices, such as those associated with the monopolization of interstate production, distribution or transportation of goods. It was supplemented by the Clayton Anti-Trust Act of 1913. More recent legislative tools to combat commercial overreaching are, among others: the Securities Act of 1933 that requires that investors in securities receive truthful information from their sellers; the Consumer Product Safety Act (CPSA) of 1972 which established the U.S. Consumer Product Safety Commission (CPSC) as an independent federal agency with the power to develop safety standards and order recalls of products that present unreasonable or substantial risks of injury or death to consumers (presently the CPSC has jurisdiction over more than 15,000 products); the Federal Trade Commission’s (FTC) Bureau of Consumer Protection which was statutorily empowered to stop “unfair, deceptive and fraudulent business practices by collecting complaints and conducting investigations, suing companies and people that break the law, developing rules to maintain a fair marketplace, and educating consumers and businesses about their rights and responsibilities.”
F. The Drafting of Commercial Private Law Statutes in the U.S., especially the UCC
The Uniform Law Commission of the U.S. (formerly the National Conference of Commissioners of Uniform State Law (NCCUSL)) prides itself in providing state legislatures with “diversity of thought (and) uniformity of law.” It describes these laws as “well-conceived and well-drafted” so that they bring “clarity and stability to critical areas of state statutory law.” As a participant in the drafting of Article 5 of the UCC, I can attest to the diversity of thought and interests as well as to the uniformity of the final legislative product. It is by far the most market sensitive statutory enactment of letter of credit law anywhere. It is also unerringly faithful to the standard banking practices although, in my opinion, not always faithful to a significant best practice: the good faith performance of the letter of credit bank’s duties which should mean not only its honesty, but also its reasonable observance of standard banking practices, was reduced to just honesty in fact in the adopted definition of good faith. Other UCC articles, such as 2 and 9 have been, with some notable exceptions, equally reflective of standard and best practices. Nonetheless, Article 2’s reliance on “merchant’s” rules adopted a professorial version of these practices at odds with the actual practices.
Part III: Comparative Contextual Contract Formation (Chapter 22)
A. Introduction
For methodological, stylistic and cultural reasons, contracts are formed, interpreted and enforced differently in countries governed by the French Code Civil and its progeny then they are under U.S. commercial law. In fact, the very concept of a contract differs in the above countries: when governed by the French Civil Code and its progeny, the sale or mortgage of valuable land is above all a ceremony, whose terms and conditions are fixed in time and space. In contrast, when the contract is a commercial sale of goods and is governed by the UCC, it is conduct of the contracting parties and occasionally of other parties involved in the same trade or profession that govern. Accordingly, the most economically important contract in the French Civil Code is predominantly static, i.e., not easily changeable or adjustable to new market conditions or circumstances. It is also a ceremonial, formal transaction. This is the case of the French Acte Authentique and of the Spanish and Latin American Escritura Publica, which are used in for what their societies regarded as the most important conveyance: the sale or mortgage of real property.
In contrast, the UCC’s sale agreement is a dynamic, non-ceremonial contract that involves moveable or personal property of every conceivable genre: corporeal or incorporeal, fungible or specially identified present or future goods. This contract could be speculative as it is with options to buy, sell or exchange things or rights in those things, or it could require a rigid and insurable mutuality of performances and can best be described as a dynamic or fluid commercial conduct. Hence, its intent is often established not only by what is stated in a written document, but by the parties’ course of performance in an existing contract, their course of dealing in previous contracts, the sectoral usage of trade and the regional or sectoral custom.
This version of a contract must be flexible enough to be easily amended and adjusted to changed market conditions, as is commonly done in agreements whose price is determined by published or unpublished market quotations, or whose supply of goods and services must be done on a “just in time” basis, or whose provision of credit is on a revolving or cumulative basis as in the above mentioned line of credit agreements, or whose grants of options to buy or sell goods are binding on their issuer regardless of the acceptance of their recipients. In contrast, in legal regimes where the failure to fulfill the “essential” formalities of a contract causes a judicial declaration of the “non-existence” or “absolute nullity” of that contract, such a contract supposedly has no legal effects whatsoever, even though in the transactional world, such a denial of existence to what already has produced lasting economic consequences is absurd.
The contrasting judicial and doctrinal reasoning and their consequences are illustrated in the case law Appendix. In it, Uruguayan, Salvadoran and Mexican court decisions appear as highly respectful of formality and ceremony as well as of the exact definition and classification of contracts. In contrast, Spanish court decisions seem to have adjusted quite well to the Spanish Civil Code’s “spiritualist” informal principle to the formation of certain contracts. In sharper contrast still, U.S. court decisions relegate formality to a secondary role and equate the contract to the parties’ conduct and trade usage.
B. Causa and Consideration as Predictors of Contract Enforceability
In the contractual practice of the French Civil Code inspired countries, the presence of a valid causa is generally determinable a posteriori, i.e., after the plaintiff or defendant in an action for breach of contract invokes the absence of a valid causa as a fatal defect of an executed contract. Example: a married man buys a life insurance policy and names his mistress as its beneficiary. The widow and heirs sue the mistress to recover the proceeds of the policy and claim it had an immoral causa. According to influential French doctrinal commentary, the causa of such a transaction is immoral if its purpose was to pay for the mistress’ sexual services; however, its cause is valid if the purchase of the policy was the result of a genuinely romantic relationship (seduction and all). Yet, how could such a contractual purpose be determined a priori by those about to enter into the supposed utilitarian or romantic relationship? What if the relationship was at first utilitarian only to become romantic for its duration or vice versa? Clearly, commercial contracts which by their nature tend to involve standardized exchanges of value require an objective, quick and a priori or ex ante determination of their enforceability. The giving of a true or symbolic consideration when executing a contract is such an objective, quick and a priori determinant of enforceability and as such, has contributed significantly to the enforcement of commercial promises and contracts.
France and Spain’s failure to develop a secondary market for negotiable commercial paper and especially of drafts or bills of exchange during the 19th century illustrates the negative consequences of a causa regime: the causa of a bill of exchange (characterized not as its drawer’s order to the drawee to pay, but as a disguised contract to buy and sell exchange) was deemed unlawful and immoral because the parties were assumed to want to evade with it the prohibition of usury on what was assumed to be a disguised loan of money at a forbidden rate of interest. Such an assumed causa prevented the negotiability of bills of exchange, a legal status which protects the bona fide purchasers of the bills from defenses or equities based upon the causas of underlying transactions between earlier parties to the same bill. In contrast, the English presumption of enforceability of contracts clothed with consideration buttressed their negotiability and with it the growth of England’s commercial, negotiable, paper market more than a century earlier.
Part IV: Good Faith, Reasonableness and Fairness in Commercial Contract Interpretation (Chapter 23)
A. The UCC and the Restatement Second’s Elements of Good Faith: The German Codes’ Contribution
The enactment of Articles 1 and 2 of the UCC and of the Restatement Second of Contracts marked a radical departure from the 19th century U.S. contract interpretation that searched for intent “within the four corners” of the written contract or “in the plain meaning of its words.” As noted earlier, the UCC and the Restatement Second led to a commercial-sectoral interpretation that deduces contractual intent from the parties’ course of the performance of an ongoing contract, in their past course of dealing or from the usages and customs of their trade. Sections 157 and 242 of the German Civil Code (BGB) of 1900 and Section 346 of the Commercial Code (HGB) of 1897 assigned to good faith the task of overseeing the legal and moral limits of such a contractual conduct. These were provisions with which Professor Karl Llewellyn had more than a passing acquaintance with when he was in charge of drafting Article 2 of the UCC. He also assigned to good faith the overseeing task and added to it the principles of reasonableness and fairness.
Reasonableness in the UCC requires that, say, a buyer of chicken, place himself in the position of an archetypal seller and ask himself (as did Judge Henry Friendly in his Frigaliment decision briefly discussed earlier): is it reasonable to expect such a seller to sell his chicken for a price that would invariably make him lose money for every pound of chicken he sold? In other words, the UCC version of reasonableness was not just to ask one party to place himself in the particular shoes of the other; it was to place himself in the position of an archetypal other. A similar principle is found in Article 8(2) of the UNCITRAL Convention for the International Sale of Goods: “… (s)tatements made by and other conduct of a party are to be interpreted according to the understanding that a reasonable person of the same kind as the other party would have had in the same circumstances.” Meanwhile, fairness or fair dealing added the requirement of contractual equality: equals must be treated equally.
B. Judicial (and mostly Procedural), Doctrinal and Market Versions of Good Faith
The Roman jurists contributed the first element of good faith: honesty in fact. The “exceptio doli” clause in the Praetor’s formula was designed to prevent plaintiffs from acting deceitfully (or with dolus) by taking advantage of the rigors of strict law. This defense, also closely associated with Roman versions of estoppel such as “venire contra factum proprium non valet” preclude a litigant from contradicting his own previous assertions, pleadings or acts. But please note that, contextually, these are judicial or procedural versions of good or bad faith, not a version determined by marketplace conduct. The disregard of the latter source of good faith is apparent, for example, in the judicial determination of contractual good faith by French courts that equate good faith to the (not necessarily commercial) diligence of a good father of family (Bon Pere de Famille) or demand unrealistic knowledge of distant commercial practices as was required from a French provincial travel agent who was supposed to inform his customer that ordinary city buses in Brazil do not carry insurance to cover accidental injuries suffered by their passengers, including tourists. These judicial and doctrinal views often equate good faith to a required level of contractual and extra contractual diligence that depends upon whether the defendant was paid for his services or by asking if the defendant delivered a promised contractual result, such as the completion of a building. What does the fact that a building was completed in time have to do with the honesty, reasonableness and fairness of its completion? If the defendant architect/builder knew that the building plans included clearly unnecessary and very costly features, did he not have a good faith duty to disclose this to his client?
This chapter finds that the German and U.S. (and to a lesser extent English) market-sensitive judicial determinations of good faith provide greater certainty and fairness to the law of commercial contracts than has been provided by French courts. It also finds that attempts to apply the analytically fashionable economic analysis of the law to good faith issues, as was done by Judge Richard Posner in a dispute involving a commercial lease (See Market Street Associates Ltd Partnership v. Frey, 941 F.2d 588, 7th Cir. 1981) fall short of their mark when they disregard standard and best market practices. Selected German, Mexican and U.S. cases in the Appendix illustrate, in some instances dramatically, the sharp differences in the judicial determination of good faith, reasonableness and fair dealing.
Part V: The Drafting of Standard and Best Commercial Contract Practices (Chapter 24)
Long lasting standard and best commercial practices result from cost effectiveness made possible by the right dosages of selfishness, altruism, honesty, reasonableness and fairness. Adam Smith, Emile Durkheim and E. O. Wilson (the latter with the help of convincing socio-biological evidence) taught us that selfishness and altruism are indispensable impulses of human cooperation and that commerce, at its best, ranks among humanity’s most cooperative endeavors. Chapter 24 studies two attempts to create long lasting commercial practices for (1) secured loans by the debtor or third party personal property and (2) cross border documentary commercial letters of credit. It took a form of secured lending that did not require the debtor’s dispossession of his collateral almost 2,000 years to develop as viable nuclear practice. On the other hand, it took cross border payment and finance by means of documentary letters of credit less than 200 years to develop as a viable nuclear practice for the entire trading and financial world. Why?
It is true that approximately 2,000 years ago Roman jurists identified the legal means by which debtors could be allowed to remain in possession of the collateral and with it to repay their debts. It also true that they were able to devise various methods for the creditors to retain, repossess and sell collateral publicly or privately. Still, they proved unable or unwilling to ensure symmetrical rights and duties for creditors and debtors. The debtors were left at the total mercy of their creditors. It took a decree by Emperor Constantine to bring a semblance of symmetry. Nor were the jurists willing or able to protect third party creditors (who were likely to rely on the same pledged or mortgaged collateral) or bona fide purchasers of the collateral. In order to do so, they would have had to install a system of public notice which only became available a millennium later for the so called Jewish Mortgages in Britain’s 13th century public registry.
It was only after the publication of Article 9 of the UCC in 1952 that the formula of viability for secured transactions using personal property as collateral was established in the U.S. and thereafter in other developed and developing nations. It created a unitary security interest that allowed both possessory and non-possessory security interests in broadly defined, present and future, corporeal or incorporeal collateral to secure the debtor’s present and future borrowings. In addition it provided a functional and accessible system of public notice and an easy and quick repayment of the secured loans, often following extra judicial proceedings. It apportioned the rights and duties of the creditors and debtors in an honest, reasonable and fair fashion and protected the rights of third party creditors and bona fide purchases in a similarly honest, reasonable and fair fashion.
In contrast to this millenary process, it took commercial documentary letters of credit less than two centuries to become a universal instrument for the payment and finance of import and export transactions. The reason for the shorter process was the interchangeability of the roles of the participating “correspondent” banks. If today’s issuing bank tomorrow acts as a correspondent, notifying, confirming, negotiating or transferring bank for other issuers, the entire set of rights and duties of these correspondents must be reasonable and fair by the very nature of the transaction. For if the practice in question favored issuing banks, say, over confirming or negotiating banks, no issuing bank would want to become such a correspondent bank and that type of correspondent banking would cease to exist. Hence, interchangeability of commercial functions among a group of regular traders or financiers insures the honesty, reasonableness and fairness of their practices. The same would be true for the regular participation of third parties because as a rule, these parties, such as applicants for the issuance of the credit, beneficiaries, holders of accepted drafts drawn against banks and transferees of the letters of credit, rely on correspondent banks for services that earn commissions, fees or interest payments for those correspondent banks.
My experience as one of the drafters of UCP 500 taught me that lawyers familiar with the banking and commercial letter of credit laws and practices played a crucial role in the drafting and success of these rules. Once all the possible practices had been identified and proposed as rules, largely by bankers, but not infrequently by lawyers, it was the lawyers’ role to guard the honesty, reasonableness and fairness of these rules and underlying practices as a legal advisor and litigant on behalf of banks, clients and beneficiaries a fortiori. Where the practices in need of rule-formulation do not stem from parties with interchangeable roles and where many of the participants are unrepresented third parties, the lawyer’s evaluation and guardianship of good faith is even a more necessary function. This chapter, including a detailed account of the drafting of UCP 500, hopes to attract interest in the drafting of customary law based rules by commercial law students, practitioners and scholars as an indispensable function of our globalized and dynamic, quickly evolving, marketplace. The same is true with the discussion on the preparation and use of field research roadmaps.
Part VI. The Breach and Remedies for Breach of Commercial Contracts
A. A Comparative Analysis of Commercial Trial and Pre-Trial Procedures (Chapters 25-30)
Chapters 25-30 deal in a chronological and comparative fashion with the adjudication of breaches of commercial contracts. It also discusses actions against negligent or malicious acts by a negotiating party whose negligence or bad faith acts (culpa in contrahendo) prevent the execution of a contract that a good faith negotiating party would have had every reasonable expectation of execution. Chapter 25 compares the “declarative” and summary or “executive” actions found in the French and Spanish families of civil and commercial procedural codes with their counterpart actions under U.S. state and federal civil procedural law.
It discusses representative pleadings (especially complaints and answers) in both systems and contrasts the finality of pleadings reflected in the civil law doctrine of ultra petita (that prevents awards for more than was asked for in the pleadings in many a civil law country) with the openness of pleadings to new facts and legal issues unexpressed in an original or amended U.S. complaint. It also contrasts the importance of fully evidence-supported findings of fact in U.S. trials with the reliance on legal and often legalistic arguments in the pleadings typical of civil law developing countries. As the first edition of this hornbook was going to print, Mexico and Chile enacted “oral trial” statutes that encourage more factually based trials and a greater reliance on interrogatories and on a rigorous examination and cross examination of witnesses. The importance of pre-trial discovery in U.S. law and in the UNCITRAL Arbitration Convention (which approved of evidence obtained in pre-trial interrogatories) was dramatically illustrated by a landmark Mexican Chamber of Commerce arbitration decision.
Following the chronology of contractual disputes, Chapter 26 deals with a pre-contractual liability for fault (culpa in contrahendo) during the negotiation of a contract. It compares Argentine, Chilean, French, German, French, Italian, Peruvian and U.S. laws and practices and finds a growing acceptance, especially in Latin American countries, of culpa in contrahendo remedies.
B. Excuses for Non-Performance (Chapter 27)
Excuses for non-performance have become quite common, especially in international commercial arbitration. The disputes usually involve significant public and private enterprises whose contracts are large enough to merit expensive litigation or arbitration designed to extricate them from excessively burdensome contracts. Chapter 27 summarizes the growing field of these excuses and relies on my comparative study, which served as basis for my testimony to an international arbitral tribunal. In accordance with the applicable law, the contract in question was a “synallagmatic” one, i.e., one in which each party agreed to give or do something in response to the other party’s giving or doing. In such contracts, especially when agreed to in writing and with the advice of experienced lawyers and economists, he who claims an excessive onerousness has to prove that his burden was so heavy and unforeseeable at the time of contracting that a rescission of the contract or an adjustment of the burden is warranted.
The chapter discusses this excuse in Italian, Honduran, Salvadorean and Argentine codes, statutes, case law and doctrinal writings; it also discusses the remedies of annulment, rescission and equitable adjustment. It studies exceptions to the admissibility of the excuse because of an express waiver by the claimant or his tacit conduct by agreeing to highly speculative or risky clauses. It compares this excuse with the Rebus Sic Stantibus doctrine (as applied in Swiss court decisions) and with excuses advocated in doctrinal Italian and German writings, notably: 1) the inconsistency of the burdensome performance with contractual presuppositions (presupposizione) or with the “foundation of the transaction” (Geshäftsgrunlage). Finally it compares the European law excuses with American ones, such as: economic injury and impracticability, physical impossibility and frustration of the contractual purpose. The observed reluctance of judges in both legal systems to grant these excuses explains the increasingly qualified nature of these excuses. It also reflects the attitude that most of the claims that reach them and arbitrators are between or among parties of equal bargaining power and business and legal skills.
C. Extra Judicial Remedies (Chapter 28)
In our day, extra judicial remedies for breach of contract are especially needed when: a) parties are separated by geography and differing legal systems, as is the case when goods are traveling across oceans or are located in a foreign country whose legal system is unsympathetic to the claims of foreign exporters, lenders, insurers or carriers; b) when the goods are quickly perishable; c) when the life cycle of transactions involving the goods and rights is very short and entails quick changes of title or of possessory rights. UCC Articles 2, 4, 5, 7, 8 and 9 resort to a growing number of extra judicial remedies as does CISG (Convention for the International Sale of Goods). These two sources enable the aggrieved seller or buyer’s to resort to extra-judicial remedies in CISG’s case by giving notice to their non-performing counter parties of their intended extra-judicial actions. The following are but a few of the growing number of extra-judicial remedies: 1) the creditors’ (including deposit and collection banks’) rights to offset credits and debits as part of the deposit and collection of checks and in clearing houses; 2) the use of escrow accounts where a trusted third party agrees to pay a performing party or return the amount he deposited upon the occurrence of specified acts or events documented for the escrow agent; 3) preclusion rights enjoyed by letter of credit banks that have presented documents for payment in a timely manner and have not received payment or a justified rejection of the presented documents in a timely manner by the confirming, issuing or paying banks; 4) UCC Article 9 “control” mechanism for debtors’ deposits in bank accounts that allow the secured creditors’ draws destined to pay the secured debt; 5) standby “counter” letters of credit where a buyer and applicant for the issuance of a letter of credit in favor of his seller also requires his seller to procure the issuance of a counter letter of credit payable to the buyer after he presents specified documents that attest to the seller’s breach in the same transaction.
The opposition to extra judicial remedies by traditionalist courts, especially in Spain and Latin America, argues that the remedies for breach of contract must always be judicial lest the parties become the judges of their own or the other parties’ performances or breaches. The volume, celerity and distant geography of contemporary contracts, especially those executed in electronic fashion, make it clear that in the not too distant future, extra judicial remedies will match if not surpass the number of judicial ones.
D. The Remedy of Specific Performance and the Obligations “to do” and “to give”
Recall Justice Oliver Wendell Holmes Jr.’s assertion that a defaulting party can always opt to breach his contract as long as he is willing to pay damages; if you agree with Professor Corbin’s assertion that the mission of contract law is to ensure the satisfaction of the parties’ reasonable expectations, specific performance obtained within a reasonable time after the breach is the remedy most consistent with the satisfaction of those expectations. Nevertheless, the trial practice of civil and common law countries shows that the award of damages is the remedy most commonly sought by and granted to the aggrieved parties.
The late Professor John Dawson’s study of Specific Performance under French, German and North American law still stands as the most learned and insightful on this topic. Among other reasons, it is because it shows how fortuitous and unreasonable lawmaking can be. He starts his account with the Roman jurist Gaius’ assertion that the recovery of monetary damages was the most generally followed rule in Rome, regardless of the type of obligation breached. He calls attention to a seemingly inconsequential comment by the jurist Ulpian on the use of the action of replevin (rei vindicatione) to recover property held by a non-owner debtor as a part of a recovery of damages owed by that debtor. This parenthetical comment was seriously misinterpreted during the following centuries by saying that in Roman law monetary damages must be granted when the breached obligation is to do something while specific performance (as in the rei vindicatione) is reserved for obligations to give something.
Apparently no one bothered to explain why giving is not a form of doing and why the doing cannot result in giving. It fell to the medieval jurist Martinus, famous for his eccentric views, to question why the failure to deliver the thing sold was not a giving entitled to specific performance. He argued that if he was starving and bought a piece of bread, he surely should have been entitled to specific performance. Yet, hundreds of years later, France’s Civil Code proclaimed in its Article 1142: every obligation to do or not to do resolves itself into damages in case of non- performance…” One of the few arguments in favor of the dichotomy was made by the medieval jurist Baldus de Ubaldis. He maintained that someone who had promised “to do” something, such as building a house, should not be compelled to do so because it would amount to a “kind of servitude” and no one should be forced into doing something (nemo potest praecise cogi ad factum). The influential (pre-code) French commentator Robert Pothier embraced this proverbial statement as a legal maxim in his Treatise on Obligations and added that it applied obligations “to do” as well as not to do something. His views appeared in the Motives of the Civil Code and have been applied as law ever since.
Yet, paradoxically, not long after the enactment of the Code, French courts imposed ostensibly stiff fines against those who breached their obligation “to do” something; if they failed to pay, they could be jailed. Unknown to many French debtors (except those represented by competent counsel), the courts were not really serious about those fines. One is tempted to ask what would have happened if Pothier and other pre-codification commentators would have asked themselves: What are the policies behind this dichotomy, if any? And if none, which policy and remedy would encourage most the performance of contractual obligations?
In contrast with the reasons for the enactment of Article 1142, the justifications for the adoption of section 241 of Germany’s Civil Code (BGB of 1900) assumed the parties’ expectations of benefiting from the agreed upon performance: “By virtue of an obligation, the obligee is entitled to claim performance from the obligor.” The Drafting Commission was aware of the equivocal role played by nemo potest praecise cogi ad factum in the enactment of Article 1142 and felt that “the incarceration of the debtor for acts whose performance could be delegated or substituted was a violation of debtors imprisonment.” On the one hand, it believed that it was “intolerable and inconsistent with…the modern law of obligations that an obligor without property should be able to defeat the execution of a judgement of specific performance merely through his own disobedience.” Hence, it agreed on a remedy in which the court orders performance of an act that cannot be delegated to a third party and whose performance depends on the will of the defaulting defendant. The applicable remedy is that of an arrest of monetary fine. Where the obligation was to deliver a thing, specific performance is available under German law for “any asset that can be attached by a Sheriff.” Thus, German courts, frequently granted the remedy of substitute performance or compliance by the debtor where the breached obligation was “to do” something. On the other hand, most German litigants resort to the remedy of damages for the majority of contractual breaches.
Dawson notes that for more than five centuries, the Common Law has relied on damages as the preferred remedy for non-performance with the exception of actions for the attachment of moveable and real property such as replevin or other extraordinary remedies such as mandamus. During this time a mixed system of damages and specific performance has been developed: it uses these remedies based on the test of adequacy of the latter remedy, another instance where the logic of the reasonable is at odds with rigid and often impracticable dichotomies.
E.Damages and Judicial Rescission and Termination (Chapters 29 and 30)
1. The Static and Dynamic Scenarios
Article 376 of the Mexican Commercial Law states: In commercial sale agreements, once the contract is perfected, the complying party will have the right to claim (in court) from the non-complying party, the rescission or performance of the contract and compensation and damages. Note the presuppositions of this remedy: 1) the plaintiff must have complied with his own contractual obligations; 2) he may then claim, in court, a rescission of the contract plus attendant compensation and damages. Thus assuming that the defendant has failed to comply, the plaintiff while still weighing the consequences of his continuous compliance must continue to comply and file the appropriate actions. Clearly, this is a static and likely quite costly scenario for the complying aggrieved party: all that this provision does is to freeze the breached transaction with the attendant and accumulating losses.
In contrast, a remedy that takes into account the dynamic and fluid nature of most commercial contracts is to allow the aggrieved performing party to suspend his performance and depending upon the seriousness of the breach, actually or hypothetically repurchase goods if he is a buyer or resell the goods if he is a seller or suspend his performance and initiate a law suit to recover his direct and consequential damages. If the sale or purchase was real, then he would be able to recover the differences between the sales or purchase contract prices, plus interest as well as additional losses, if any. If the sale or purchase was hypothetical, his profits or losses would have to be estimated in accordance with hypothetical transactions at reasonable times and places. The rationale for these remedies is contrary to the rationale employed by Justice Holmes when he allowed the “bad man of contracts” to breach and pay damages. For the rationale for these dynamic remedies is that contracts must be performed, and even if the aggrieved party suspects a future breach, Section 2-609 of the UCC entitles him to request from the possibly breaching party “adequate assurance of performance.” One can hardly tell a contracting party, on the one hand, “breach if you like” and on the other, grant the right to the other party to demand adequate assurances of performance. The extra-judicial remedies for rescission and termination of commercial contracts therefore, must provide a flexible overall compensation including the possibility of punitive and lost volume sales damages.
Chapter 29 relies on American Bronze Corporation v. Steamway Products 456 N. E. 2d 1295 (1982 Ohio App.) for an eagle eye discussion of the numerous flexible damage remedies available under Article 2 of the UCC. While the remedial terminology and analysis is not always precise and consistent with that in other jurisdictions, it provides a complete remedial excursus. The terminology is contrasted with that used by Spanish professors, Luis Diaz Picazo and Antonio Gullon, also former justices of Spain’s Supreme Court. While the latter is more technically accurate, the flexibility of the remedies in American Bronze, is much more consistent with the nature of dynamic commercial contracts. The Appendix contains useful German decisions on the operation of the notice by the aggrieved to the non-performing party known as the nachfrist, which was used in the CISG as a successful bridge between European and UCC rescissory remedies.
2. Damages for Breach of Warranty in U.S Economic Analysis of the Law
In his concise account of the law of warranties in the common law, Professor Sir Roy Goode points out that while caveat emptor was the reigning principle of liability for a defective product in the common law, no independent actions for breach of warranty existed. Actions before merchants and criminal courts punished those who tempered with products, such as beer and wine, or who used false weights and measures. With the exception of sales of edibles and beverages, sellers were not bound by implied warranties of quantity and quality. Sellers had no obligation to disclose latent defects known to them. It was not until the 19th century that an action for implied warranties was granted when the buyer relied on the seller’s description of the goods or the goods were unfit for the buyer’s purpose which was known to the seller.
With the publication of Article 2 of the UCC in 1952, the link between the inspection of the goods and the seller’s liability for implied warranties of the goods, especially for the warranty of merchantability (the ability of the goods to pass in commerce as would any similarly labelled or described) and the warranty of fitness for the purposes known to the seller was decoupled from the buyer’s inspection of the goods. Regardless of such an inspection, if the goods were defective as measured by these standards, the buyer was entitled to flexible damages that would enable him to recoup costs and lost profits. As pointed out in an enlightening comparison of implied warranties in some civil law countries and in Article 2 of the UCC, the former fell considerably short of warrantying what was available under the latter, especially because the only recovery available under the Spanish and Latin American “rehibitory action” was for hidden or latent defects. If the defects could be easily discovered by the buyer’s inspection, he was not entitled to implied warranty damages. As quoted by the U.S. federal court decision in Taylor and Gaskin Inc. v. Chris Craft Industries: “the rule that has emerged from the state court analyses of Sections 2-714(3) and 2-715 (2) is consequential damages which result from the seller’s breach of warranties are recoverable to the extent that the seller had reason to know that such damages would follow from the breach…”
The decision in R.E. Davis v. Chemical Corp. v. Diasonics Inc. (924 F.2d 709, 7th Cir. 1991) illustrates the positive contribution that the judicial awareness of economic laws or principles such as the law of supply and demand, and the relationship between prices and cost of opportunity can have when deciding issues such as the following in the appellate court’s remand to the trial court: (W)e reverse and remand the case with instructions that he district court calculate Diasonic’s damages under Section 2-708 (2) if Diasonics can establish not only that it had the capacity to make the sale to Davis as well as the resale to the resale buyer, but also that it would have been profitable for it to make both sales and that Diasonics probably would have made the second sale absent the breach…”
Clearly, it would help the court decision to understand concepts such as marginal costs, costs of opportunity and economies of scale when determining the capacity to make a resale and the profitability of making two sales, as opposed to only one. As it would also help the court to know what a similarly situated archetypal seller would have done under the circumstances. Yet, where economic analysis of the law becomes metaphysical and thus not necessarily accurate and useful is when attempts to predict commercial behavior and fashion new rules by relying on vague archetypes such as the “efficient” homo economicus, including the perpetrator of “efficient breaches.” For, in the name of an ill-defined efficiency, this archetype is likely to promote practices that tip E.O. Wilson’s scale of commercial cooperation in favor of an excessive, uncooperative selfishness. In addition, if the issue requires the determination of contractual good faith, the efficient homo economicus would not understand why the required behavior must not only be honest but also reasonable and fair.