Corinna Engel - European Law Blog !
My presentation at the University from 8th October 2018 about Harmonization of European Contract Law through an Optional Instrument
My presentation today is about ‘Harmonization of European Contract Law’ through an ‘Optional Instrument’.
In this presentation, I will mainly look at how scholars have interpreted some topical pieces of legislation or proposal legislation in the recent years.
First, I would like to make a summary of the history of European contract law:
As the main objectives of the EU is to ensure effective functioning of the internal market, it’s important for the EU to be successful in harmonizing Member States law. In the area of equality law and the implementation of the four principles, namely the free movement of goods, workers, persons and provision of services, the Union has enjoyed some of success in the harmonization of Member States law, whereas in the field of contract law attempts to harmonize Member States private laws have been far more sporadic, and the Union’s approach to harmonize contract law has involved so far issuing directives in specific areas of contract law, predominantly consumer contracts, such as doorstep and distance selling contracts. The reasons for these approaches to harmonize contract law is because there is a big divergence in European contract law, which creates obstacles for businesses and consumers engaging in cross-border-trade.
Nonetheless, the attempts to harmonize contract law by directives has been ineffective, because the divergence in European contract law still creates obstacles for business and consumers.
Therefore, harmonization of contract law has been quite ineffective and has resulted in fragmentation within the European Union. That is why the European Parliament called on the European Union to take necessary steps hereto.
In 1999, the Tampere European Council conducted an overall study on the need to approximate Member State’s legislation in civil matters. And following this, the Commission issued in 2001 a communication with the aim to gather information on whether there was a need for EU action in European contract law. Further action followed by the Commission in 2010 by issuing a ‘Green paper’ on policy options proposing different approaches to harmonize Contract Law for consumers and businesses. This has led some commentators to the view that the Commission favors an optional contract law instrument based on rules of the DCFR (Draft Common Frame of Reference). The DCFR is the result of academics done by networks and it is about certain principles, definitions and model rules of European Private Law.
In sales and goods and digital content, a similar approach has been made by means of a proposal of a Regulation setting out a ‘Common European Sales Law’. This has been approved by the Parliament and is awaiting consideration by the Council. If approved, the CESL would be available for adoption by the parties or relevant contract. In February 2014, however, the parliament adopted its legislative resolution on the CESL proposing to limit its scope to cross-border business-to-consumer transactions only.
Harmonization by directives: problems and the search for an alternative solution
Europeanisation of contract law has so far been fraught with problems, why is that?
A notable cause poses the minimum harmonization, as the directives with minimum harmonization cause that the Member States can only harmonize laws to a certain extent. (means that it sets a threshold which national legislation must meet)
-And maximum harmonization doesn’t allow Member States to adopt laws that go beyond consumer protection standards, which again keeps divergence. (means that national law may not exceed terms of legislation) So, instead of creating a level of playing field for businesses, minimum harmonization rather enables the Member States to maintain existing rules than enact new provisions.
One of the problems to harmonize Contract Law is minimum harmonization, as I already said in the beginning, as it enables Member States to maintain existing national rules rather than enact new provisions to give proper effect to the directive.
Another point to argue about is whether the minimum harmonization simply shifts the degree of diversity between national laws? An example hereto is the Distance Selling Directive. Article 6 of this directive gave consumers the right to withdraw from contracts without giving any reason for a period of 7 working days.
The imposition of minimum harmonization by this directive meant that the Member States could provide for a longer cooling off period. The result was uncertainty for businesses engaging in cross border trade because they didn’t know about the cooling off period on other Member States.
A British supplier, for example, who sells throughout Europe, for example, would need to know that 7 days cooling off period applies to England, Belgium, Spain and Netherlands but 10 days in Italy and 2 weeks in Germany, plus the manufacturer has to inform the consumer about their right of cancellation, and if they inform the consumer wrongly, this means the cooling off period never starts and the consumer will have a further 3 months cooling off period. This means huge losses for the supplier and deters suppliers from marketing and selling across the European Union.
That’s why Vivienne Reding criticized the minimum harmonization as well by saying that 2 of every 3 consumers trying to buy from another country were turned down.
These examples show that divergence cannot be addressed through minimum harmonization.
Therefore, a proposal for consolidation of the 4 directives (Distance selling, Unfair contract terms, sales of consumer goods and Doorstep selling directives) was made by the Commission in 2008, the directive of adopted maximum harmonization, which means the Member States are restricted from going beyond or below. An example can be found in article 9 of the Consumer Right Directive, where all the Member States provide a uniform 14 days withdrawal period. But it has yet to be seen if maximum harmonization will lead to a greater convergence in contract law.
The optional instrument: solution to legal fragmentation?
One of the solutions put forward by the European Commission is the creation of an optional contract instrument. It would not replace national law but rather would sit alongside Member States contract law. However, there are concerns about such an instrument. Firstly, there would be a lack of clarity whether the optional instrument would be on an opt-in or opt-out basis, and it rises the next question whether this instrument should only be limited to cross-border transactions or expanded to internal contracts? If indeed the optional instrument was be limited to cross-border trade only, then 2 businesses would have to trade under two legal systems, namely the optional instrument and the national laws.
In this case, the businesses operating cross-border would be forced to adapt their standard contract terms to benefit from the instrument. And it rises another question, namely if the instrument would be applicable to both business to business and business to consumer contracts (B2C). As the goal behind harmonization of contract law is to encourage cross-border between businesses, the instrument would certainly cover B2C contracts as well. In so far as B2C contracts are concerned, the Commission foresees the optional instrument as a complementary tool to the existing consumer acquis, by integrating its requirements, including progress made on consumer protection in the internal market in the Consumer Rights Directive.
The EU treaties do not lay down specific competences empowering the EU to harmonize private law. However, several possibilities have been discussed by academics over the years, mostly Art. 114 and 352 of the Treaty on the legal basis for the adoption of consumer protection directives and legislative acts in contract law. Art. 114 TFEU allows the European Parliament and the Council to adopt measures for the approximation of the provisions laid down by the law in a Member State, which have as their object the functioning of the internal market. Art. 114 has been used also as the basis for the proposed regulations on a Common European Sales Law.
Art. 352 TFEU provides the Eu with a power to attain one of the objectives set out in the Treaties, and where the treaties have not provided necessary powers. For that purpose, the Union utilizes this article to adopt instruments such as for example the ‘Societas Europea’, among others, which exist alongside national forms, and which provides the parties with a choice. From this point of view, we can say that Art. 352 offers legal backing for the optional instrument. On the other hand, measures based on Art. 352 TFEU requires the consent of the European parliament and unanimity of the council. Some issues discussed here may be affected by the applications of the rules of private international law, the 2 Rome regulations, Rome I and Rome II. Rome I applies to contractual obligations and Rome II to pre-contractual negotiations. In B2B contracts, if there is conflict, then generally the law of the seller or supplier will apply. In B2C contracts, the law of the consumer’s jurisdiction will apply, so sellers of Member States will have to deal with different laws, depending on the location of the consumer.
The Commission considered the interrelationship between the optional instrument and private international law in its 2004 Communication the techniques that may be adopted to give effect to the optional instrument. For this purpose, several options were submitted.
The first concerns article 20 of the Rome Convention (the precursor to Rome I and Rome II). This article gave priority to European Union rules ‘relating to contractual obligations’ over those stipulated in the Rome Conventions. This shows that the optional instrument could co-exist with private international law.
Article 20 does not foresee the creation of an optional instrument but Rome I gives implicit reference to the optional instrument in article 22. Here, the second option involves the adoption of an optional instrument, which means that the contracting parties first select the optional instrument as the applicable law to their contract.
Comparative contract and substance of the optional instrument (Draft Common Frame of Reference)
We have seen so far that for the European Commission, there are difficulties to approach the contract law.
We have seen so far here the constitutional and practical issues, which an optional instrument for the contract law could impose. In the following, I want to talk about various case studies regarding contract law in the European Union by analyzing certain aspects of French, German and English contract law.
I will focus in the following on 3 different case studies, which deal with the pre-contractual good faith and the possibility of an optional instrument being based on the Draft Common Frame of Reference (DCFR).
Case I Study:
The Doctrine of Good Faith:
In the case of Itech, computer manufacturer from Lincoln, the company negotiated with a German company over a prolonged time giving them the feeling it would come to a deal.
Without informing the German company, it started parallel negotiations with Smartbits. It broke off then with the German company and made the deal with Smartbits. The German company wished to claim damages then. However English law recognizes the freedom of contract without regard for its inherent fairness, thus companies can withdraw from contractual negotiations before the contract is concluded.
In this case, the judge Lord Ackner criticized the Doctrine of Good Faith to which the German company referred to and stated that the concept of Good Faith is inherently repugnant to the adversial position of the parties when involved in negotiations, and considered an agreement to negotiate in Good Faith wasn’t binding and thus unenforceable in contrary to German law, where the court probably had hold Itech liable for breach of the duty of Good Faith.
In France, for example. French law might had as well concluded that Itech’s abrupt departure from the negotiations amounted to ‘abus de droit’. There is the freedom of negotiation in French law subject to the obligation to negotiate in good faith. If the above dispute however was subjected to German law, the outcome could have been a different one.
It is well established in German law that parties can break free from negotiations without fear of liability. However, the doctrine of good faith imposes certain duties on parties conducting negotiations (§311 (2) (1) of the German Civil Code (GBG)), means that a party, which has entered negotiations is under the obligation to have regard to the other party’s rights, to negotiate in good faith.
This duty includes the obligation on each party not to break off the negotiation without good reason once that party has encouraged in the other party a confident expectation that the contract will come into existence. So, in this case with Itech, it seems likely that the German court would hold Itech liable for breach of the duty of good faith.
How could be the outcome with a French party?
As we have seen in these cases, there is divergence in national laws which causes obstacles to cross-border trade. Firstly, the dismissal of the doctrine of Good Faith by English courts may well deter firms in Germany and France from entering business with companies based in England. Second, the uncertainty of clarity regarding the good faith in French law may have dire consequences for English companies ignorant of French law.
Another case, which is the case of ‘Yum Seng Pte Limited V International Trade Cooperation Limited’ however recently softened English courts approach to the doctrine of good faith, because the judge Leggatt suggested on that case that the ‘traditional English hostility’ towards a doctrine of good faith in the performance of contracts is misplaced and that contractual obligation of honesty could be implied in the performance of some contracts, particularly those which are of a ‘relational character’.
In another case, the ‘Mid Essex Hospital Services NHS Trust V Compass Group UK and Ireland Ltd’, the contract contained a specific obligation to cooperate in good faith, which the trial judge found had been broken. The court of Appeal however, disagreed with LJ Jackson stating that there is no general doctrine of good faith in English contract law. LJ Beatson approved J Leggatt’s emphasis on context but felt in the present case that the judge had given insufficient weight to specific provisions in other parts of the contract and warned against construing.
The approach adopted by J Leggatt however, has been subsequently applied by the High Court in Bristol Groundschool Limited V Intelligent Data Capture Limited’, because, as the judge noted that this approach had not been disapproved by the court of Appeal in the ‘Mid Essex case’, and found that there was on the facts an obligation to act in good faith.
The question is whether the different positions would be clarified by the adoptions of the provisions of the DCFR?
To this end, Art. II-3;301 DCFR contains provisions addressing contract issues where a party to a negotiation acts contrary to good faith and fair dealing. It lays down that a party is free to negotiate and accepts the parties right to break-off from negotiation. However, the freedom of contract envisaged by the DCFR is not absolute but restricted by the duty of ‘good faith and fair dealing’.
Par. 4 stipulates that it is contrary to good faith and fair dealing to enter into or continue negotiations with no real intention of reaching an agreement. An application of par. 4 would suggest Itech had breached the duty of good faith by failing to inform the German company while continuing to negotiate with no real intentions of completing the agreement, Therefore, in pursuant to par. 3 Art. II-3:301 DCFR, Itech will be liable to compensate the German company for the costs and expenses arising out of the breach.
However, in practice determining what constitutes ‘good faith and fair dealing’ is difficult.
Case Study II
The English company ‘Designbricks’ won a bid to build four new schools for Nottinghamshire County Council. A contract provision was that Designbricks had to fit all the school buildings with solar panels. To finish in time the work, Designbricks decided to subcontract. It received 2 offers, 1 from a German and 1 from an English solar panel manufacturer. After making the offers, both manufacturers wish to revoke their offers immediately. Designbrick responded to the German manufacturer suggesting a variation in the German company’s terms. The German manufacturer remained silent however.
Case Study III
The manager of a cosmetic shop in France received a shopping catalogue from an English company with multiple outlets based in London. In the catalogues were a list of cosmetic products. Each product had a price clearly written next to it. The manager informed the company in London that it had accepted its offer. However, the English company refused to sell the products at the stated prices saying that the manager had simply made an offer to buy, and they were not bound to this. The manager now wants to be compensated.
In case study II and III, we can see the different national laws. In case study II, an English court would have said that the revocation was effective, because it says before acceptance, there is no contract. The German Civil Code stipulates however that an offer is binding on the offeror and cannot be revoked until a reasonable time has expired. Thus, the German company would not be able to revoke its offer with immediate effect.
About case study III, the French manager will not be entitled to any compensation under English law because it states that advertisement at a price do not constitute an offer but rather an invitation to treat. In contrast French law considers advertisements as offer.
Besides the problem of good faith, we can see in these case studies that offer, withdrawal and acceptance differ in different countries and thus affect cross-border commerce.
Regarding revocation of offer under the DCFR, the article which is relevant here is Art. II.-4:202: ‘An offer may be revoked if the revocation reaches the offeree before the offeree has dispatched an acceptance or, in cases of acceptance by conduct, before the contract has been concluded’.
Reactions from business community
Before drawing a final conclusion, due regard must be given to the views of the business community because they are the potential end users of the optional instrument. In a survey in 2005 Clifford Chance LLP showed that 82 % of the respondent businesses said they would ‘very likely’ use an optional instrument if created. In Poland the figure was even 100 %. Nevertheless, the above result should not be taken as conclusive evidence, because the samples of business participants were small (175). And for example, the results from Spain were just based on 12 respondents. And it was admitted that the sample was not in accordance with the distribution of enterprise by size in Europe. And this greatly weakens the significance of the results, of course.
We have seen today that divergence in contract law hinders cross-border trade. And the continuous use of minimum and maximum harmonization has failed to achieve greater convergence. For a better regulation, a proposal has been advanced by the European Commission. This was the optional instrument. The instrument has optional nature. And by using the optional instrument, they could save costs of legal advice. However, the optional instrument is not realizable and unlikely to obtain its objectives, because the scope of the optional instrument would be of disadvantage for the harmonization process. More problems over its legal basis and a treaty change might be necessary for a legal basis.
And if the optional instrument would be based on DCFR, it will require cases to be tested in court, due to lack of jurisprudence, as for example the principle of ‘good faith and fair dealing’ has not been adequately defined. Similarly, the wider obligations attaching to an ‘invitation to treat’ in the DCFR may cause considerable difficulties in practice, especially to common law lawyer. Meanwhile, businesses operating under the potential instrument may find themselves entangled in costly litigation, precisely the kind of legal wrangling that the optional instrument seeks to avert.
As to the way forward, the difficulties expressed in the previous section rather show that an optional instrument should be avoided but more energy should be put into improving European laws. And finally the role of the DCFR should be narrowed for a meaningful purpose, and rather than providing the basis for an optional instrument, it should be regarded as a ‘toolbox’ to assist judges and Member States in making and interpreting the law. An example of this approach is to be found in the judgement of Lord Malcolm in the recent Scottish case of ‘Phil Willis v Strategic Procurement (UK) Ltd.’ Which raised a question about the law of error. In this case Lord Malcolm looked at the relevant provisions of the DCFR to evaluate the decision he had reached after having formulated a view based on the Scottish authorities. This approach may well indicate the best way of providing a role for the DCFR in the process of achieving greater harmonization of contract law across Europe.