Limits to Party Autonomy in International Commercial Arbitration

3.1 Force Majeure clause

An example of a contract term that may have different legal effects depending on the legal framework, is the so-called Force Majeure clause. This clause is meant to excuse a party’s non-performance of its obligation, if fulfilment were prevented by an event which was beyond that party’s control, unforeseeable and could not be reasonably overcome. One question is how the requirement of ‘beyond control’ shall be interpreted. Interpretation may be influenced by the legal system’s understanding of the assumptions about liability.

An illustration of this situation is where a producer cannot fulfil its obligations because it did not receive raw materials from its supplier. The question is whether failure by a party’s supplier may be deemed as an event falling outside of that party’s sphere of control. To answer this question, it is necessary to understand the purpose of the Force Majeure clause.

There may be several goals for a regulation on exemption from liability for non-performance. In some legal systems, the aim is to allocate between the parties the risk for supervening unexpected events according to which one of the two parties is closer to bear that particular risk. This approach assumes a strict liability, which is triggered irrespective of the conduct of the party that was prevented from performing its obligations.

According to an alternative approach, the risk for unexpected events should not be borne by a party, as long as that party has acted diligently and cannot be blamed for the occurrence of the impediment - even if in an objective allocation of risk that party would be closer to bear such risk.

The legal systems that follow the criteria of the strict liability and the allocation of risk between the parties according to the respective spheres of control, would consider the choice of supplier to be an event falling within the sphere of control of the seller. Certainly this impediment would not fall within the sphere of the buyer and, since all risks have to be allocated between the parties, it follows that it must fall within the sphere of the seller. That the producer has been diligent in selecting its supplier and cannot be blamed for the supplier’s failure to deliver is not relevant.

This is the approach taken by English law.⁹ German law, however, has a different approach. According to §276 of the German Civil Code (Bürgerliches Gesetzbuch; BGB), if the prevented party is to be blamed for the impediment or its consequences, it cannot be excused from liability. If, however, the prevented party can prove that it has not acted negligently, it will be excused from liability. If the seller has operated with diligence in the choice of supplier, it would not be considered liable for non-performance due to failure by the supplier.

The distinction between common law and civil law in the context of liability for non-performance can be explained¹⁰ by the English system’s inclination to privilege predictability for the sake of ensuring that business is carried out smoothly, rather than ensuring that an equitable justice is arrived at in a given case. Common law allocates the risk of non-performance between the parties according to where it is most closely to expect that the risk should be borne. This objective rule is not to be defeated by subjective criteria such as lack of negligence, because it would render the system less predictable. Civil law systems privilege (in different degrees) the subjective elements of a specific case, in order to ensure that an equitable solution is reached.

The interpretation of the Force Majeure clause, therefore, is not absolute and uniform, but depends on the governing law.

3.2 Entire Agreement clause

Another example of a term of contract that may be interpreted differently depending on the legal framework, is the so-called Entire Agreement clause. This is a recurring clause in contract practice, and states that the document signed by the parties contains the whole agreement and may not be supplemented by evidence of prior statements or agreements.

The purpose of the Entire Agreement clause is to isolate the contract from any source or element that may be external to the document. This is also often emphasised by referring to the four corners of the document as the borderline for the interpretation or construction of the contract. The parties’ aim is thus to exclude that the contract is integrated by terms or obligations that do not appear in the document.

The parties are, of course, entitled to regulate their interests and to specify the sources of their regulation. However, many legal systems provide for ancillary obligations deriving from the contract type,¹¹ a general principle of good faith¹² or from a principle preventing an abuse of rights.¹³ This means that a contract would always have to be understood, not only on the basis of the obligations that are spelled out therein, but also in combination with the elements of the applicable law which integrate it. A contract, therefore, risks having different content depending on the governing law: the Entire Agreement clause is meant to avoid this uncertainty by barring the possibility of invoking extrinsic elements. The Entire Agreement clause creates an impression of exhaustiveness of the written obligations.

This is, however, only an illusion: first of all, ancillary obligations created by the operation of law often may not be excluded by the contract.¹⁴ Moreover, some legal systems permit bringing evidence that the parties’ agreement creates obligations which differ from those contained in the contract.¹⁵ Furthermore, many civilian legal systems openly permit the use of pre-contractual material to interpret the terms written in the contract.¹⁶ Finally, a strict adherence to the clause’s wording may, under some circumstances, be looked upon as unsatisfactory even under English law, in spite of the formalistic interpretation style that English law may employ in respect of other clauses.¹⁷

The effect of the clause, therefore, does not flow from its simple words, but is the result of a combination of the clause and of the governing law.

3.3 No absolute and uniform effects

The examples set out above show that national law may be relevant even in situations where the assumption of the closed circuit is not challenged by judicial control. Even though arbitral tribunals in these situations are allowed to consider exclusively the terms of the contract without running the risk of triggering invalidity or unenforceability of the award, they may find that the terms of the contract are not a sufficient basis for the decision and must be integrated by external elements.

4.1 Force Majeure clause

To test the ability of transnational law to overcome the disparity of legal traditions, we can look at the examples given in Section 2 above. We saw that the expression ‘beyond the control’ in Force Majeure clauses may be interpreted differently depending on the governing law. Does transnational law offer a uniform solution?

One of the most successful instruments of contract law harmonisation is the 1980 Vienna Convention on Contracts for the International Sale of Goods (CISG). It is ratified by over 60 countries and looked upon, especially in some academic circles,²² as embodying principles that are generally recognised and reach well beyond the convention’s scope of application.

According to Article 79 of the CISG, a party is not liable for failure to perform its obligations, if it proves that the failure was due to an impediment beyond its control, which was unforeseeable and that could not reasonably have been overcome.

The CISG does not contain any reference to the diligence of the affected party as a criterion for exempting it from liability; in another context, the Convention confirms that diligence is not a criterion for excuse: Articles 45(1) (b) and 61(1)(b) provide that each party may exercise contractual remedies for non-performance against the other party without having to prove any fault or negligence or lack of good faith on that party, nor do they mention that any evidence of diligence would relieve the other party from its liability.

The Secretariat Commentary²³ does not address the question of how the criterion of the sphere of control shall be interpreted, whether literally, or as a reference to the diligent conduct of the seller. Bearing in mind that the CISG shall be interpreted autonomously, without reference to domestic legal systems, it seems appropriate to interpret the Convention literally and see Article 79 objectively dividing the landscape into two spheres, that of the seller and that of the buyer, without reference to specific actual possibilities to exercise control. This is confirmed by case law and doctrine: procurement risk falls within the seller’s sphere of risk Therefore, failure by the seller’s supplier does not fall outside of the seller’s sphere of responsibility (unless the relevant good has disappeared completely from the international market).²⁴ In the comment to the second paragraph of Article 79 on use of sub-contractors, the Commentary specifies that this special rule does not include suppliers of raw material or of goods to the seller.²⁵

However, this is not the only way of understanding the criterion of ‘beyond the control’. Article 79 of the CISG may be interpreted differently, depending on the interpreter’s legal tradition – something that has been designated as ‘troubling’.²⁶

Norway implemented the CISG with the Act on Sale of Goods.²⁷ The latter introduced in §27 the concept of impediment beyond the control of the prevented party, with a literal translation of Article 79 of the CISG. By introducing this concept, the legislator intended to mitigate the then existing regime, which was based on strict liability.²⁸

Norwegian legal doctrine²⁹ interprets the criterion of ‘beyond the control’ not as having an abstract understanding of each party’s sphere of control, but on the basis of the actual sphere of control of each party. Only if one party actually has the possibility of influencing a certain process, events caused by that process are deemed within the sphere of control of that party. That a party has started a process does not, in itself, mean that any events occurring in the course of that process are in that party’s sphere of control. The test must be if that party actually had the possibility of influencing the part of the process in connection with which those events occurred. Hence, in the case of procurement risk the interpretation of what is ‘beyond the control’ is opposite to the outcome under the CISG: the producer chose its supplier, and this choice is certainly within the producer’s sphere of control (it could have chosen another supplier, and then the default would not have happened). However, the producer has no actual possibility of influencing the performance of the supplier; therefore any impediment in connection therein shall be deemed outside of its sphere of control.³⁰

In conclusion, the CISG does not seem to provide a uniform standard for the interpretation of Force Majeure clauses.

4.2 Entire Agreement clauses

The other example of a contract term with inconsistent legal effects made in Section 2 above, is the Entire Agreement clause.

This clause is recognised in Article 2.1.17 of the UPICC and Article 2:105 of the PECL, with some restrictions: the provisions specify that prior statements or agreements may be used to interpret the contract. This is one of the applications of the general principle of good faith; it is, however, unclear how far the principle of good faith goes in overriding the clause inserted by the parties. If prior statements and agreements may be used to interpret the contract, does this mean that more terms may be added to the contract? Say, for example, that the parties have discussed certain specifications at length during the negotiations and this has created in one of the parties the reasonable expectation that these specifications would be implied in the contract even though they were not included in the final contract text. Article 1.8 of the UPICC would seem to indicate that this would be the preferred approach under the UPICC. According to this provision, a party may not act in a way inconsistent with reasonable expectations that it has created in the other party. This is spelled out in the PECL Article 2:105 (paragraph 4) of which states that ‘A party may by its statements or conduct be precluded from asserting a merger clause³¹ to the extent that the other party has reasonably relied on them.’

According to this logic, the detailed discussion during the phase of negotiations of certain characteristics for the products may create the reasonable expectation that those specifications have become part of the agreement even if they were not written in the contract. Their subsequent exclusion on the basis of the Entire Agreement clause may be deemed to be against good faith.

According to the opposite logic, however, the very fact that the parties have excluded from the text of the contract some specifications that were discussed during the negotiations indicates that no agreement was reached on those matters. Exclusion of those terms from the contract, combined with the Entire Agreement clause, strongly indicates the will of the parties not to be bound by those specifications. Their subsequent inclusion on the basis of the good faith principle would run counter the parties’ intention.

The foregoing shows that the application of the UPICC and of the PECL requires a specification of the principle of good faith. Is it intended as an overriding principle, possibly creating, restricting or modifying the obligations that flow from the text of the contract? Or is it meant to take the text of the contract as a starting point, ensuring that the obligations contained therein are enforced accurately and precisely as the parties have envisaged them? This represents the dichotomy between, on the one hand, the understanding of fairness as a principle ensuring balance between the parties-notwithstanding the regulation that the parties may have agreed on- and, on the other hand, the understanding of fairness as a principle ensuring predictability, and leaving it to the parties to evaluate the desirability of their contract regulation. This dichotomy characterises the different approaches of the common law and the civilian tradition.³² To enhance the ability of the UPICC to harmonise contract law, in 1992 UNIDROIT has created a data base collecting court decisions and arbitral awards on the various provisions of the UPICC. This is, therefore, the best source to turn to when inquiring how to interpret the Entire Agreement clause under the UPICC.

As per 2013, the Unilex database contained five decisions on Article 2.1.17 of the UPICC. Elsewhere, I have analysed these decisions, revealing that they are not based on a consistent understanding of the standard according to which the clause shall be applied.³³ The Unilex database shows two approaches to Article 2.1.17 of the UPICC: one advocating the primacy of the contract’s language, and the other assuming that the UPICC provides for the primacy of the parties’ real intentions, which in turn may lead to considerably restricting the effect of the Entire Agreement clause.

Evidently, this is not sufficient to provide guidance as to which approach to choose when addressing the conflict between the contract’s language and the principle of good faith. This leaves so much room to the discretion of the interpreter, that it seems unlikely for UPICC Article 2.1.17 to give a harmonised regulation of its subject-matter. The UPICC, therefore, does not contribute considerably to a harmonised standard of interpretation.

4.3 No uniform legal framework

The examples made above show that submitting a contract to the CISG, the UPICC or other transnational sources does not necessarily ensure that the contract will be interpreted independently of the applicable legal tradition. The transnational law, therefore, does not ensure the closed circuit.

5.1 The dynamics of contract drafting

As described elsewhere, the dynamics of contract drafting often involve inserting some of the clauses in a contract without the parties having given any particular consideration to their content or their effects under the applicable law.³⁵

This practice may be surprising, considering the importance that the governing law has for the application and even the effectiveness of contract terms, as was seen above. However, the practice of negotiating detailed wording without regard to the governing law, or even of inserting contract clauses without having negotiated them, is not necessarily always unreasonable. From a merely legal point of view, it makes little sense, but from the overall economic perspective, it is more understandable. The gap between the parties’ reliance on the self-sufficiency of the contract and the actual legal effects of the contract under the governing law does not necessarily derive from the parties’ lack of awareness regarding the legal framework surrounding the contract. More precisely: the parties may often be conscious of the fact that they are unaware of the legal framework for the contract. The possibility that the wording of the contract is interpreted and applied differently from what a literal application would seem to suggest, may be accepted by some parties as a calculated risk.³⁶

Considerations regarding the internal organisation of the parties are also a part of the assessment of risk. In large multinational companies, risk management may require a certain standardisation, which in turn prevents a high degree of flexibility in drafting the single contracts. In balancing the conflicting interests of ensuring internal standardisation and permitting local adjustment, large organisations may prefer to enhance the former.³⁷

It is, in other words, not necessarily the result of thoughtlessness if a contract is drafted without having regard for the governing law. Neither is it a symptom of a refusal of the applicability of national laws. It is the result of a cost–benefit evaluation, leading to the acceptance of a calculated legal risk. The sophisticated party, aware of the implications of adopting contract models that are not adjusted to the governing law and consciously assessing the connected risk, will identify the clauses that matter the most, and concentrate its negotiations on those, leaving the other clauses untouched and accepting the corresponding risk.

A faithful interpretation of the contract assumes an understanding of this uneven approach to contract drafting.

5.2 The need for predictability

While contract drafting may be uneven, predictability is extremely important in commercial contracts. The parties are interested in enforcing their rights, and for this purpose they depend on one or more national legal systems and their courts. Once a contract is finalised, therefore, parties are interested in its enforceability and in the predictability of the parameters according to which enforcement may be achieved.³⁸

Litigation lawyers carefully analyse the specific contract and its effects under the governing law, and try to assess as precisely as possible the possibility of winning a case in court or in arbitration on the basis of the contract wording, the applicable law and the degree of factual background that the governing law allows to bring into the dispute. Thus, on the one hand, drafting lawyers, while negotiating a contract, may have willingly disregarded the legal effects of some clauses. On the other hand, litigation lawyers, while assessing enforceability of the same contract, will carefully study its legal effects under the governing law. The varying degree of awareness during negotiations must accordingly be considered in light of the need for predictability once a dispute arises.

Furthermore, contracts are often meant to circulate, for example, because they are assigned to third parties, are used as security or serve as a basis for calculating insurance premiums. In these situations, it is essential that contracts are interpreted strictly in accordance with their terms: third parties are not aware of and should not be assumed to take into consideration the relationship between the original parties to the contract, what the original parties may have assumed or intended, or any circumstances that relate to the original parties and that may have had an impact on these parties’ interests. It is, therefore, expected that a contract is interpreted primarily, if not exclusively, in light of its terms – without considering things such as what a fair balance between the parties’ interests would be or what one party’s expectations might have been.

5.3 How to square the circle: the applicable law

The arbitral tribunal is expected to understand the dynamics of negotiations in order to properly give effect to the intention of the parties. Blindly applying the wording of the contract without any regard to the principles of the governing law or, to the extent that they are determinable and applicable, of transnational law, would not necessarily reflect the true intention of the parties if the clause that is being applied literally is one of the boilerplate clauses that the parties did not consider. Yet integrating or correcting a clause with national or transnational principles might not necessarily reflect the parties’ intention either, if the clause that is being interpreted is one of the clauses that the parties carefully negotiated.

Leaving broad discretion to the interpreter, however, runs the risk of undermining predictability, if the criteria for exercising such discretion are not clearly determinable. As was seen above, interpretation of the contract should take into consideration the need for predictability. Overriding the terms of the contract in the name of principles of good faith or equity would hence lead to results that are not compatible with the expectations of international business practice, if the standards that are applied are not clearly determinable. From the overview made in section 3 above, it seems that the standard of good faith is not sufficiently determinable on a transnational level. It may therefore be advisable to take in to consideration the criteria developed in the applicable law.

5.4 Variety of approaches

There is no uniform answer to the question of what interpretation is the most faithful to the parties’ intentions. A seminar organised at the University of Oslo in 2011³⁹ discussed the arbitrators’ approach to the interpretation of contracts and identified a variety of approaches.⁴⁰

Contracts are not necessarily always applied in strict accordance with their terms. There are different degrees of interference and the sources of the interference also vary quite considerably. There is a scale moving from a strict application of the governing law to integrate the contract, via interpretation of the contract terms in the context of transnational soft law principles such as the UPICC and the PECL (which are heavily based on the principle of good faith and may give rise to a substantial possibility of interfering with the contract language), to interpretation of the contract on the basis of its own terms combined with the parties’ interests and trade usages, to interpretation of the contract solely on the basis of its own terms. There is also a further approach to interpretation of the contract, which goes under the label of ‘splitting the baby’. This Solomonic approach consists of rendering an award in the middle range between the claims of each of the parties. This is not necessarily based on a literal consideration of the contract terms or on an integration of the contract with other sources, but simply on the desire to accommodate the interests of both parties.⁴¹ Interestingly, there does not seem to be a uniform perception of the frequency of this approach. A recent empirical study shows that the parties to arbitration perceive that they received a Solomonic award in 18–20% of the cases, whereas the arbitrators perceive that they take this kind of equitable decision in only 5% of the cases.⁴² This, therefore, adds a new variable to the equation of the interpretation of contracts. Not only is it uncertain whether the arbitrators will interpret the contract literally, whether they will use sources of law or whether they will apply transnational principles to give a more purposive interpretation; it is also possible that the decision will be influenced by equitable considerations that are not based on the contract or on other legal sources.